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i

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iii

Strategic Studies Institute

and

U.S. Army War College Press

THE STRATEGIC IMPORTANCE 

OF THE GLOBAL OIL MARKET

Leif Rosenberger

June 2015

The views expressed in this report are those of the author and 

do not necessarily reflect the official policy or position of the 

Department of the Army, the Department of Defense, or the U.S. 

Government. Authors of Strategic Studies Institute (SSI) and 

U.S. Army War College (USAWC) Press publications enjoy full 

academic freedom, provided they do not disclose classified 

information, jeopardize operations security, or misrepresent 

official U.S. policy. Such academic freedom empowers them to 

offer new and sometimes controversial perspectives in the interest of furthering debate on key issues. This report is cleared for 

public release; distribution is unlimited.

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This publication is subject to Title 17, United States Code, 

Sections 101 and 105. It is in the public domain and may not be 

copyrighted.
iv

*****

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be forwarded to: Director, Strategic Studies Institute and U.S. 

Army War College Press, U.S. Army War College, 47 Ashburn 

Drive, Carlisle, PA 17013-5010. 

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v

*****

The author would like to thank Commodore Richard Menhinick, the Director of the Combined Strategic Analysis Group 

(CSAG) at U.S. Central Command (CENTCOM), for reviewing 

this manuscript and for the opportunity to do research for Azimuth Check #15 which culminated in CSAG Strategy Paper #7 

on February 12, 2015, on the impact of global oil market trends, 

growing U.S. oil independency, and the Central Region’s oil regimes and their implications for the wider region.

ISBN 1-58487-686-7

vii

FOREWORD

In the past year, oil prices have plummeted. At 

first glance, the U.S. economy as a whole appears to be 

a big winner. Newspaper headlines talk about “America’s oil independence.” In Carlisle, PA, we can gas up 

our cars in late-March 2015 for less than $2.50 a gallon. 

That means more money in our pockets for consumer 

goods. Therefore, consumers are big winners and are 

rejoicing. Is it time for a victory parade? 

Not so fast, says Dr. Leif Rosenberger, the Chief 

Economist at U.S. Central Command. As someone who 

has spent 3 1/2 decades connecting economics and security as a scholar, educator, and now a practitioner 

in the U.S. Government, Dr. Rosenberger reminds us 

that, in economics and international business, appearances can be deceiving. He points out that shale oil 

producers in the United States are learning a bitter lesson about the cyclical nature of the international oil 

market. The more they produce, the more oil prices 

fall and the more their profits get squeezed. 

Dr. Rosenberger argues that low oil prices have 

created the worst slump that the global oil industry 

has faced since 1986. Oil companies in the United 

States are fighting for survival. They are forced to cut 

capital spending to the bone and lay off thousands of 

their employees. In contrast, state owned oil groups 

in the Middle East can dip into their sovereign wealth 

funds or oil stabilization funds and weather the storm. 

Saudi Arabia feels it can price the oil producers in the 

United States out of the market. 

Why is this a strategic issue? At a time when 

the United States is seeking cooperation with Saudi 

Arabia and the rest of the Gulf Cooperation Council 

(GCC) to counter the Islamic State in Iraq and Syria 
(ISIS), the United States and Saudi Arabia are in a de 

facto price war. Dr. Rosenberger makes the argument 

that the coalition will struggle if the United States and 

the GCC are determined to run each other’s oil companies into the ground. Dr. Rosenberger is especially 

concerned that the U.S. corporate approach to cutting 

costs and capital spending could result in a lack of oil 

production in 4 or 5 years. This short-sighted corporate mismanagement may well create conditions for 

a dramatic rise in oil prices, possibly hitting as high 

as $200 a barrel. Instead of this chaotic boom and 

bust cycle, Dr. Rosenberger argues for more energy 

cooperation and price stability. 

He concludes that the time to set up institutions 

to avert these counterproductive price wars or to create energy banks to mitigate them is long overdue. 

Therefore, he recommends the creation of a bank as 

a lender of last resort for oil companies. However, a 

bank that bails out oil companies in distress is not all 

that is needed. Dr. Rosenberger persuasively argues 

that what is also needed is an early warning system 

for the oil industry. 

Therefore, if strategists are going to be successful, 

they need a clear understanding of the forces that determine the supply and demand for oil. Such an understanding will help them shape national policy on 

matters with potentially unprecedented consequences. What is needed from world leaders is an unprecedented level of cooperation in the formulation of a 

long-term international oil strategy. One consequence 

of failure could be resource-driven conflicts that might 

have been avoided had policymakers understood the 

nature and extent of the world oil supply and taken 

steps to deal with it.

viii
ix

The real danger is to relegate the world oil supply 

to the backwater of strategic studies. Strategists need 

to understand that the world oil supply is a global 

challenge that bears most heavily on the peace and 

prosperity of the international system. World leaders have an unprecedented opportunity to move this 

global issue to the top of their agendas. If they fail, 

their successors may have to deal with the problem 

“when it comes to visit” as a major and enduring crisis 

in the not too distant future.

 

DOUGLAS C. LOVELACE, JR.

Director

 Strategic Studies Institute and

 U.S. Army War College Press

xi

ABOUT THE AUTHOR

LEIF ROSENBERGER worked at the Central Intelligence Agency (CIA) and the Defense Intelligence 

Agency (DIA) from 1980 to 1986, and in the Strategic 

Studies Institute (SSI) and the Department of National 

Security and Strategy at the U.S. Army War College 

(USAWC) from 1986 to 1998. He was the Chief Economist at the Pacific Command (PACOM) from 1998 to 

2008. He has been the Chief Economist at U.S. Central 

Command (CENTCOM) since 2008. At the CIA and 

the DIA, he was a pioneer in tracking terrorist financing after the bombings in Beirut in 1983. He ran the 

24-hour alert center on counterterrorism in the Pentagon and was the first U.S. analyst to expose external support to the Philippine New People’s Army. 

At USAWC, he held the General Douglas MacArthur 

Academic Chair of Research. He was promoted from 

Associate to Full Professor of Economics in 1993. He 

remains an SSI Adjunct Professor. At PACOM, he authored two books on Asian economies that received 

the highest 5-star ratings from the Australian National 

University. Admiral William Fallon brought him from 

PACOM to CENTCOM where he has been a policy 

entrepreneur, initiating the New Silk Road Initiative, 

which transformed U.S. economic policy in Afghanistan. Admiral Jeffrey Harley appointed him as Chief 

of the New Silk Road Task Force, a 1-star equivalent 

position. Secretary of State Hillary Clinton made the 

New Silk Road Initiative U.S. policy. Dr. Rosenberger 

has also been a prolific writer. In addition, he is an accomplished educator. He taught the core curriculum 

and international economics at USAWC. He taught 

International Business in the Executive MBA Program 

at the University of Hawaii in 2006 and received the 
xii

highest student evaluation. He spent his sabbatical 

year of 1997 as a Visiting Scholar on Economic Faculty 

at Harvard University, funded by a U.S. Secretary of 

the Army Research & Study Fellowship. He was chosen as PACOM Professional of the Year and U.S. Federal Employee of the Year in 2006 and 2007. General 

David Petraeus awarded him the Joint Civilian Service Commendation Medal. Admiral Fallon awarded 

him the Chairman Joint Chiefs of Staff Joint Meritorious Civilian Service Medal. He won four faculty writing awards at USAWC. In 2008, Access Asia ranked 

him its top expert out of 700 specialists on the Asian 

economy. Dr. Rosenberger graduated from USAWC in 

1989 and won the student writing award; holds a B.A. 

with honors from Harvard University; an M.A. from 

Boston University; and a Ph.D. in international relations from Claremont Graduate School, where he held 

the Merit Fellowship as the top ranking student. He 

also passed five doctoral exam fields in international 

economics, international politics, and U.S., Soviet, and 

Chinese foreign policies.
xiii

SUMMARY

This Letort Paper will explain why the confluence 

of four major factors: 1) rising oil supplies, 2) weak 

oil demand, 3) financial shifts on Wall Street, and 

4) a strong U.S. dollar far outweigh the geopolitical 

risks in the Mideast and put downward pressure on 

oil prices. This Paper analyzes the concomitant factors that are now putting upward pressure on oil 

prices, as well as those that continue to keep oil prices 

relatively low.

On the supply side, lower oil prices in part reflect 

booming U.S. oil production. The real “game changer” 

is the recent discovery of 30 more years of unconventional oil. The global oil market is now “swimming” in 

one trillion more barrels of oil that was not included 

in the world oil supply a few years ago. This new oil 

supply mostly breaks down into three types of unconventional extraction of oil: Brazil’s deep water oil, U.S. 

shale oil, and Canada’s oil sands. 

On the demand side, there continues to be a sluggish global economy. For instance, Japan, Germany, 

and Italy are all suffering from near economic contraction. China’s growth is rapidly slowing down and 

is a far cry from its double digit growth in the past. 

Meanwhile, the U.S. economy was also weak after the 

global financial crisis. In an effort to boost gross domestic product growth, the federal government (Fed) 

under Ben Bernanke loosened the monetary policy 

(increased the growth of the money supply), which in 

turn caused oil prices to rise as a hedge against expected inflation and a weak dollar, but runaway high 

inflation never happened. So now the Fed (under Janet Yellen) is planning to tighten monetary policy by 

reducing (or tapering) the pace of growth of quanti-
xiv

tative easing, which, in turn, will strengthen the U.S. 

dollar. A stronger U.S. dollar buys more oil and therefore lowers crude oil prices.

In sum, the major factors that determine average 

oil prices have all been pointing in a downward direction. In fact, in 2015, there is likely to be a growing surplus of oil on world markets created by rising oil production in the United States, Canada, and a few other 

countries. The result has been falling oil prices. Low 

oil prices have created winners and losers. Winners 

include the global economy as a whole, and consumers, especially U.S. consumers, and net oil importing 

countries. Losers include oil investors, net oil exporting countries, oil producing companies, and the workers that have been laid off by these oil exporting companies and countries. This Paper discusses why the 

winners are benefitting, why the losers are suffering, 

how the winners and losers are responding, and how 

their responses will affect oil prices down the road.
1

THE STRATEGIC IMPORTANCE 

OF THE GLOBAL OIL MARKET

PART I: INTRODUCTION 

The global oil market in early-2015 is not what it 

used to be. In the past, environmentalists used to warn 

everyone that the world would soon run out of oil. 

Not anymore. If there is one thing that is certain these 

days, it is that the world has plenty of oil. Thanks to 

breakthroughs in energy technology, the new game 

changer is the recent discovery of 30 more years of oil 

supply (or one trillion more barrels of oil) than oil experts said existed only a few years ago. This new oil 

supply involves unconventional oil extraction of shale 

oil in the United States, oil sands in Canada, and deep 

water oil in Brazil.

In the past, Saudi Arabia was the swing producer. 

If the Saudis cut oil production, prices rose. Not anymore. When Saudi Arabia cut production in August 

2014, oil prices actually fell. Rising U.S. oil production 

more than offset Saudi cuts in oil output. As a result, it 

is now clear that U.S. shale oil producers are now the 

swing oil producers. 

In the past, geopolitical risks from military conflicts 

like we are seeing today in the Middle East would 

often cause oil prices to rise. Not so much anymore. 

Short of a major oil disruption in the Mideast, low 

oil prices now reflect an oil glut outweighing weak 

demand for oil. Geopolitical risk is a minor driver. 

In the past, Wall Street used to worry about inflation. This was particularly true after the global financial crisis when the federal government (Fed) bought 

a trillion dollars’ worth of global assets to boost weak 

global demand. That spooked Wall Street, which felt 
2

the Fed was creating runaway inflation. As a hedge 

against inflation, Wall Street investors bought vast 

quantities of oil in the futures market. That distorted 

the market and drove oil prices sky-high, but investors guessed wrong. Inflation never happened. Long 

positions in high oil prices were unwinding, and that 

lowered oil prices. 

In the past, economists also used to worry about inflation.1

 Not anymore. On a global basis, serious economists are no longer worried about inflation. The new 

worry is deflation and weak demand in Japan and the 

Eurozone, and a rapid Chinese economic slowdown. 

That, in turn, weakens the global demand for oil.2 In 

contrast, the combination of the U.S. economy being 

on a roll and the expectation that the Fed will tighten 

its monetary policy in the 3rd quarter of fiscal year 

2015 has strengthened the U.S. dollar and lowered oil 

prices in U.S. dollars. 

This Letort Paper will explain why the confluence 

of four major factors: 1) rising oil supplies, 2) weak 

oil demand, 3) financial shifts on Wall Street, and 4) a 

strong U.S. dollar, far outweigh the geopolitical risks in 

the Mideast and put downward pressure on oil prices. 

In December 2014, global oil prices had fallen about 

50 percent from their peak in mid-July 2014. However, 

oil prices are rising again. Brent crude oil jumped 21 

percent in early February from its closing low of January 13. Oil had not risen this fast since March 2009. 

Why is this happening? Is this rise sustainable? This 

Paper will also analyze the concomitant factors that 

are now putting upward pressure on oil prices, as well 

as those that continue to keep oil prices relatively low. 

When oil prices dropped significantly in the past, 

the Organization of Petroleum Exporting Countries 

(OPEC) would simply cut their production to bolster 
3

the price. So why did OPEC not do the same thing 

again? Actually, Saudi Arabia announced that it cut 

oil production by 400,000 barrels a day in August 

2014. There was no increase in oil prices as non-OPEC 

oil production surged to more than offset Saudi cuts 

in a world swimming with an oil supply surplus. U.S. 

oil production hit a 28-year high in August. Libyan 

oil production surged from 200,000 barrels a day to 

800,000 barrels a day several months ago.3 As a result, 

prices actually fell because rising oil production outweighed Saudi cuts in output. What is more, growing budget deficits in many OPEC countries in recent 

years make it far more difficult to cut oil production 

because these countries can no longer afford the loss 

of their oil revenues.4

Where Is All This New U.S. Oil Production 

Coming From?

In large part, lower oil prices are the result of 

booming U.S. oil production. Horizontal drilling 

and hydraulic fracking have raised U.S. crude oil 

output by more than 65 percent in the past 6 years. 

Between 2011 and 2013, the United States raised its 

output by 2.2 million barrels of oil a day, more than 

the entire increase in global demand. Innovation has 

made Eagle Ford in south Texas, Bakken in North Dakota, and Permian Basin in West Texas the industry’s 

equivalents of Silicon Valley.5

Warren Henry, Conoco’s head of investor relations, is bullish on Bakken’s production, and compares it to Saudi Arabia in the 1950s. In February 2014, 

EOG Resources announced a 45 percent increase in 

its oil reserves in Eagle Ford (from 2.2 billion to 3.2 

billion barrels). Official U.S. data supports these up-
4

beat assessments: U.S. Government Energy Information Administration (EIA) has recently published 

rising output from new wells in Eagle Ford, Bakken, 

Permian, and the Niobrara formation of Colorado.6

In many ways, the United States is taking on the 

role of “swing producer” that was once played by 

Saudi Arabia. This rising U.S. oil production acts as 

financial offsets to geopolitical risk. Even if more geopolitical disruption occurs in the Central Region, rising U.S. oil production serves to soften the blow from 

these disruptions and keep downward pressure on 

oil prices.

Of course, the United States is not alone in boosting its oil output. Libya boosted its oil output from 

400,000 barrels a day in July 2014, to 740,000 barrels 

a day by September 9, 2014. In addition, a few other 

countries like Canada, Brazil, and Mexico also have 

plans to boost production and help the United States 

meet demand, but there is still a great burden of 

expectation riding on the U.S. output.

What Does the Demand for Oil Look Like?

The other factor driving down oil prices is weak 

demand. For instance, in June 2014, oil refineries in 

Europe ran at sharply lower rates. At the end of July 

2014, producers of West African crude, which normally sells to the United States and Europe, had trouble 

finding buyers. As a result, crude oil stockpiles rose 

significantly. Crude oil and refined product supplies 

rose 9.5 million barrels by September 1-5, 2014.7

This weak demand for oil reflects a sluggish global 

economy. For instance, Japan, Germany, and Italy are 

all suffering from economic contraction. In addition, 

China’s imports fell for the second straight month in 
5

August 2014 and its gross domestic product (GDP) 

growth is the slowest since 1990.8 While China is still 

growing at 7.4 percent in 2014, that is a far cry from 

China’s double digit growth in the past.

What Does the Long View Look Like?

However, the real “game changer” is the recent 

discovery of 30 more years of unconventional oil. The 

global oil market is now “swimming” in one trillion 

more barrels of oil that was not included in the world 

oil supply a few years ago. This new oil supply breaks 

down into three types of unconventional extraction of 

oil: deep water oil, 317 billion barrels; shale oil, 345 

billion barrels; and oil sands, 388 billion barrels.9

In the past, petroleum had a monopoly on transportation. Not anymore. Trucks, buses, and ships are 

starting to use natural gas instead of gasoline to fuel 

their engines. In addition, older engines are being 

retrofitted. In Brazil, one-third of the cars are already 

using fuel other than petroleum. To sum up, the combination of 30 more years of unconventional oil supply and weaker demand for oil is putting downward 

pressure on global oil prices over the next 5 years.

Why did Monetary Policy Drive Up Oil Prices?

After the 2008 financial crisis, the Fed (under Ben 

Bernanke) needed to boost GDP growth. The Fed cut 

interest rates and printed trillions of dollars’ worth 

of new currency via “quantitative easing (QE).” This 

huge growth of the money supply increased the desirability of hard assets such as oil (and other commodities) as a hedge against the expected risk of a falling 

U.S. dollar and rising inflation.10
6

How did Financial Markets Affect Oil Prices?

Since the global financial crisis in 2008, institutional investors have poured into the crude oil market, which caused prices to soar 140 percent from their 

post-financial crisis lows.11 Large institutional investors that placed a record bullish bet on high oil prices typically capture the middle part of large market 

moves. Not surprisingly, as late as June 2014, money 

managers, including hedge funds, continued to place 

record bets on rising U.S. and Brent oil prices.12

Institutional investors are often wrong at important market turning points. The massive inflation and 

a weak dollar that they expected to occur as a result of 

the Fed’s loose monetary policy turned out to be illadvised and unlikely to occur in the near future. The 

increasing awareness that this assumption was off the 

mark is shaking up Wall Street.

Meanwhile, the actual producers and users of 

crude oil (the Exxons and British Petroleums [BP]) 

use the futures market as a form of insurance against 

adverse price moves. These commercial hedgers are 

considered to be the smart money because they are 

the physical crude oil market and have firsthand info 

about the future supply and demand trends we cited 

previously.

Commercial hedgers now have a record 445,492 

net contract short positions in the crude oil futures 

market, which indicates that their greatest concern 

is a sharp decline rather than an increase in crude 

oil prices. Commercial crude oil hedgers are well 

aware of the bearish points discussed earlier, which 

likely explains why they are hedging and betting on a 

coming crude oil bust.
7

The impulse to sell has been growing for weeks. 

Traders have watched oil producers shift their hedging and trading of future contracts that are years away. 

That is a good sign that producers see supply coming 

on strong without demand to absorb it for a long time. 

Many traders have unwound their bets on high oil 

prices they made back in June 2014.13 On August 5, 

2014, their cumulative bets on rising oil prices on the 

New York Mercantile Exchange (NYMEX) fell to the 

lowest level since January, and bets on higher prices 

for Brent Crude hit the lowest level since February 

2014.14

Speculators are the least bullish on U.S. crude oil 

prices in over 17 months. Money managers have cut 

their net-long positions for West Texas Intermediate 

(WTI) by 9.2 percent in the week ending on September 

2, 2014. The same week ending September 2, net-long 

positions for Brent crude oil dropped to their lowest 

levels since July 2012.15

How Will Changes in Monetary Policy 

Affect Oil Prices?

As stated earlier, the U.S. economy was weak after 

the global financial crisis. In an effort to boost GDP 

growth, the Fed (under Ben Bernanke) loosened the 

monetary policy (increased the growth of the money 

supply via QE), which in turn caused oil prices to rise 

as a hedge against expected inflation.

However, runaway high inflation never happened. 

So now the Fed (under Janet Yellen) is planning to 

tighten monetary policy by reducing (or tapering) the 

pace of growth of QE, which in turn will strengthen 

the U.S. dollar. A stronger U.S. dollar buys more 

oil and therefore lowers crude oil prices (which are 

traded in dollars).
8

In addition, the European Central Bank (ECB) is 

fighting slow economic growth throughout the European Union (EU),16 and is finally cutting its interest 

rates and considering its own QE, which consists of 

selling the Euro and buying large amounts of foreign 

assets, thus weakening the value of the Euro. This large 

QE at ECB and tighter money at the Fed will send the 

U.S. dollar even higher and oil prices even lower.

How Do All These Factors Affect Future Oil Prices?

To sum up, the major factors that determine average oil prices have all been pointing in a downward 

direction. In fact, in 2015, there is likely to be a growing surplus of oil on world markets created by rising 

oil production in the United States, Canada, and a few 

other countries. The result has been falling oil prices.17

On a yearly basis, the world oil supply is about two 

million barrels a day above demand, according to the 

January 31, 2015, The New York Times. While all four 

factors listed thus far are still responsible for low oil 

prices, the major new development remains the United States, Canadian, and Brazilian surge in nonconventional oil production. 

Low oil prices have created winners and losers. 

Winners include the global economy as a whole, consumers, especially U.S. consumers, and net importing countries. Losers include oil investors, net oil exporting countries, oil producing companies, and the 

workers that have been laid off by these oil exporting 

companies and countries. This Paper will discuss: 

a) Why are the winners benefitting? 

b) Why are the losers suffering? 

c) How are the winners and losers responding? 

d) How will their responses affect oil prices down 

the road?
9

In January 2015, the leading economists attending 

the World Economic Forum—including many Nobel 

Prize winners—argued that the global economy would 

be a big winner from the low oil prices. They said the 

economy would receive a significant boost from low 

oil prices in 2015. How significant? They compared it 

to the monetary policy equivalent of the Fed’s huge 

quantitative easing. The International Monetary Fund 

(IMF) calculates that the 55 percent reduction in oil 

prices from its mid-2014 peak boosts global GDP by 

over 1 percent. Since the global economy as a whole 

is still relatively weak since the global financial crisis 

and the great recession, this macroeconomic “shot 

in the arm” thankfully prevents the deflating global 

economy from slowing down even more. 

PART II. U.S. QUEST FOR OIL INDEPENDENCE

At first glance, the U.S. economy as a whole is a 

big winner from low oil prices. Newspaper headlines read, “America Near Energy Independence,” or 

“America: The New Saudi Arabia.” U.S. consumers 

are also winners. The benefits of low oil prices in the 

United States are readily apparent on Main Street. Until recently, regular gas in Tampa, FL, was under $2 a 

gallon as of late-January 2015. More broadly, the nation’s 200 million drivers will save an average of $750 

this year, thanks to lower gas prices. Combined with 

lower heating bills, this will put an extra $20 billion in 

the pockets of U.S. consumers. All that extra money 

translates into more consumer spending that fuels 

U.S. economic growth. Oxford Analytics calculates that 

the U.S. economy would grow a full percentage point 

faster than when oil prices were at their recent peak in 

mid-July 2014. 
10

Is it time, therefore, for a victory parade? Quite the 

contrary. In economics, appearances can be deceiving. 

If we dig a little deeper, we discover that all is not well 

with U.S. oil producers. U.S. shale oil producers are 

learning about international business. They are also 

learning that the international oil market is cyclical. 

Back in mid-2014, oil prices peaked at $115 a barrel. 

During this Phase One, the market share of U.S. shale 

oil producers was on the rise. Profits were high. It 

seemed like the best of times. Unfortunately, those 

heady days were short-lived. 

Before long, U.S. shale oil producers were in a painful Phase Two and the victim of their own success. The 

more they produced, the more oil prices fell, and the 

more their profits got squeezed. U.S. oil production 

hit 9.2 million barrels a day in January 2015—a 31-

year high. Unfortunately, this surge in oil production 

was totally mismanaged and helped to create a huge 

oil glut.18

To be fair, U.S. shale oil producers are not the only 

ones creating this glut. The Bank for International 

Settlements correctly argues that heavy financial trading on oil futures is also to blame for pushing down 

oil prices and creating this boom and bust cycle. In 

2005, daily oil futures volume in oil was only 3.4 times 

global demand. In 2015, daily oil futures volume in oil 

is over 20 times global demand.19 In addition, a strong 

dollar and a weak global economy were also weakening oil prices. That said, there is no question that in 

early-2015, the extraction of U.S. shale oil is fuelling an 

oil glut. The crude oil market is now over-supplied by 

as much as 2 million barrels a day. As a result, crude 

oil inventories are now at an 80-year high for this time 

of the year.20

In early-January 2015, the price of oil plunged 

below $50 a barrel—and nearly a 6-year low.21 Can 
11

this surge in U.S. oil production last? That question 

turns on the so-called break-even cost of U.S. oil. The 

critical question, therefore is: How low do oil prices 

have to go before U.S. shale oil cannot make a profit 

and is priced out of the market? Some estimates put 

the break-even cost for U.S. shale at $60-$70 a barrel. 

Other estimates say the break-even cost is $50 a barrel. 

Actually, the question is difficult to answer because 

the cost of shale oil varies, depending upon where it is 

produced. U.S. shale oil producers in Eagle Ford, TX, 

can compete with the Saudis at a lower break-even 

point than U.S. shale oil producers in Bakken, ND, or 

Permian Basin, TX. 

The volatility in the market makes it difficult to 

locate the oil market’s floor at this point. However, 

one thing is clear: The oil sell-off is already having an 

impact. While a durable price recovery may not be imminent, signs are mounting that the tide is turning. 

The most tangible price effect is on the supply side. 

In this sense, a low oil price is performing its role in 

discouraging more supply. While there is no evidence 

yet of an actual reduction in overall global oil production, there is plenty of evidence of cutbacks in spending and investment that will ultimately affect the supply in the future.22 For instance, in 2014, discoveries 

of new oil dropped to their lowest level in at least 2 

decades. That translates into tighter world oil supplies 

and upward pressures on oil prices in the future.23

With prices falling below $50 a barrel, a business 

as usual approach is a nonstarter because this would 

put oil companies in the red. U.S. oil companies have 

been forced to adapt to the new low oil price environment. Toward that end, oil companies have been cutting their budgets and postponing or cancelling “cash 

negative” new projects, while, at the same time, trying 
12

to be more efficient in squeezing the most out of their 

fields already in production.24

In this regard, the market is especially excited that 

BHP Billiton and BP both cut their number of rigs by 

40 percent.25 The drilling rig count in the United States 

has fallen 24 percent in the last 4 months from a high 

of 1,609 to 1,233.26 In early February, Baker Hughes, 

the oil services group, announced that the number of 

its rigs drilling for oil in the United States fell to the 

lowest level since December 2011, and down 29 percent from its October 2014 peak. HIS Energy reported 

that daily utilization rates for its state-of-the-art ultradeep-water rigs hit a 15-year low in January 2015.27

In addition, Conoco and Occidental both cut capital 

spending by 33 percent.28

Traders on Wall Street took this 40 percent drop in 

the number of active rigs drilling for oil and the large 

cuts in capital spending by major oil companies as two 

positive indicators that actual cuts in oil production 

and higher oil prices are on the way. As a result, Brent 

crude oil jumped 21 percent in early February from 

its closing low of January 13. Oil had not risen this 

fast since March 2009. Is this rally the start of a bull 

market? 

There is no question that the conditions that will 

ultimately propel oil prices higher are now visible, but 

it will take a while to unwind the two million barrels 

a day of oil glut. U.S. oil production is still 9.2 million 

barrels a day—a 31-year high. Oil inventory is still at 

an 80-year high for this time of the year. 

In addition, signs of a demand response to low oil 

prices remain elusive. On Wall Street, many traders 

tend to harbor negative sentiment towards betting on 

high oil prices after losing billions the last time that bet 

failed. So many traders can be expected to push down 
13

oil prices, at least for a while. On Main Street, drivers 

do not commute twice a day to work just because gas 

prices are lower. In addition, fuel efficiency standards 

are being tightened in many major car markets. As we 

will see in Part IV of this Paper, the demand for oil 

remains weak in many net oil importing countries. 

In assessing the corporate response to low oil prices, the good news is the oil companies are maintaining market share and providing their shareholders 

with dividends. The bad news is low oil prices forced 

Schlumberger to cut 9,000 jobs and Brent Hughes to 

cut 7,000 jobs. At a time when the skill-sets of older 

oil technicians are in short supply, this approach is 

arguably short-sighted. 

In this regard, Eni Chief Executive Officer (CEO) 

Claudio Descalzi is correctly concerned that the corporate approach to cutting costs and capital spending 

could result in a lack of oil production in 4 or 5 years 

and a dramatic rise in oil prices. This short-sighted 

corporate mismanagement will arguably create the 

conditions for a dramatic rise of oil prices, possibly as 

high as $200 a barrel. Instead of this boom and bust 

scenario, Descalzi persuasively argues that we need 

stability.29 If countries like Norway have an oil stabilization fund to stabilize oil prices for that country, why 

not have a United Nations (UN) global stabilization 

fund to stabilize oil prices for the world? Instead of oil 

prices triggering boom and bust, we could have international financial buffers to soften the blows. Descalzi 

recommends a “central bank of oil, like we have in 

the financial system, to give stimulus and to stabilize 

[prices].”30

How bad is the situation? BP Chief Bob Dudley argues that low oil prices have created the worst slump 

the oil industry has faced since 1986. Wood McKen-
14

zie analysts go a step further and warn that low oil 

prices pose the biggest threat to oil and gas industry 

earnings and financial solidity since the financial crisis 

of 2008.31 In this regard, it is important to understand 

that oil is used as collateral in many transactions. In 

fact, the U.S. shale revolution was largely financed 

by debt that must now be repaid. As a result, lower 

oil prices could easily spill over into financial turbulence.32 The cuts that oil companies are now making to 

survive could hurt other companies and other areas of 

the economy.33

The great New York Yankee catcher Yogi Berra 

would call this “déjà vu all over again.” Back in the 

summer of 2007, the price of mortgage bonds and related derivatives fell. U.S. Fed Chief Ben Bernanke dismissed it as an isolated problem. He said these would 

be relatively small losses on subprime mortgages and 

limited to $25 billion.34 Well, guess again. The financial 

losses were 100 times higher and spread to the whole 

financial system.

Chris Flanagan, head of Securitization at Bank of 

America Merrill Lynch, recently compared the trajectory of the Brent crude oil price to the index of subprime mortgage derivatives in 2007. He found the 

patterns almost identical to the origins of the global financial crisis. As Flanagan puts it, “We may have seen 

this movie before.”35 Similarly, Timothy Lane, deputy 

governor of the Bank of Canada, told an energy conference in Wisconsin that central bankers are “alert to 

the possibility that financial linkages could transmit 

stress from oil markets to the financial system.”36

So is it time to press the panic button? No. That 

is because there are a number of reasons why low oil 

prices will arguably not trigger another financial crisis. First, as we said earlier, oil prices have a positive 
15

macroeconomic impact on the global economy. Second, the regulators are not asleep this time. Canadian 

banks are doing stress tests to see what happens if oil 

falls to $35 a barrel. Third, regulators have already 

forced financial institutions to build up bigger financial buffers to soften the blows that the stress tests are 

creating.37 Fourth, regulators are on the lookout to 

make sure oil is not used as collateral for nonoil related 

financial deals. Fifth, aside from oil companies, 2014 

was a good year for stock market earnings. Sixth, the 

economy is diversified, therefore, the strong revenues 

behind the nonoil companies reflect the underlying 

strength of a U.S. economy that does not just depend 

on oil sales. That said, there is no reason for financial 

complacency. 

PART III. IMPACT ON OIL REGIMES IN THE 

CENTRAL REGION

Now let us look at Saudi Arabia and the other Gulf 

Cooperation Council (GCC) oil producers and compare them to U.S. oil producers. Saudi Arabia and the 

other OPEC oil producers in the Middle East are in a 

bitter price war with U.S. and Canadian oil producers.38 OPEC members told BP CEO Bob Dudley that 

Saudi Arabia and its partners wanted to “fundamentally test” the oil market to see if U.S. shale oil producers who had led America’s output boom could continue pumping crude oil at lower prices. Bob Dudley’s 

comments point to a battle of wills ahead as Saudi 

Arabia and its oil partners wait to discover if their decision not to cut oil production knocks out higher cost 

production in the United States and Canada. 39

Who is winning this price war? In this battle of 

wills, the United States and Canada flinched first. 
16

North American drilling activity is dropping off more 

sharply than elsewhere in the world. For instance, 

Baker Hughes saw a 15 percent drop in the number 

of rigs drilling for oil in the U.S. from October 2014 to 

January 2015. In contrast to the United States, Middle 

East state-owned groups are much more resilient. In 

fact, Mideast oil companies have very few reductions 

in oil rigs. For instance, there was a drop of just one 

oil rig in Saudi Arabia, from 67 in October to 66 in 

December.40

This sharp difference becomes clear if we look at 

Schlumberger, Halliburton, and Baker Hughes, the 

three largest international service companies that support oil and gas producers with activities such as drilling, completing, and analyzing wells. All three say 

their activities are dropping off much more sharply in 

North America than in the Mideast. Spending by Schlumberger’s customers, which include both the major 

and smaller companies, is dropping by 25-30 percent 

in North America. Similarly, Halliburton is reportedly cutting spending by 25-30 percent in the United 

States. By contrast, corporate spending in the Middle 

East has not fallen much at all. A survey of oil companies’ capital spending intentions published by Barclays earlier in February 2015 paints a similar picture. 

Capital spending in the Mideast has only been cut by 

1 percent. In contrast, U.S. capital spending is on track 

to fall anywhere from 14 percent to 30 percent. 

The faster downturn in the North American industry is in part explained by the higher costs of U.S. 

and Canadian shale production compared with oil 

from the Middle East. However, there are particular 

features of the U.S. shale industry that enable it to react faster. First, the individual investments are small, 

making it more flexible. Second, the small and medi-
17

um-sized companies that have led the U.S. shale boom 

have been running large cash deficits and relying on 

constant inflows of debt and equity capital to finance 

their spending. Third, the production decline rates for 

shale wells are much steeper than for conventional oil: 

daily output can fall 65 percent in the first year. 

As we move from the costly unconventional extraction of oil in the United States and Canada to the 

less costly conventional oil in the Central Region, a 

key question is: Are countries in the Central Region 

with largely conventional extraction of oil also at risk 

from low oil prices? The short answer is that some of 

them in the short run are less affected from low oil 

prices than others. The Saudis, the United Arab Emirates (UAE), and Kuwait are arguably in the best shape 

to ride out the low oil prices. In contrast, Libya and 

Iran are more vulnerable. 

Why the differences? Some of the OPEC countries 

are in a better financial position to withstand the impact that low oil prices are having on their national 

budgets. Qatar and UAE became less vulnerable by 

diversifying their economies and not relying on oil as 

a “one trick pony.” As a result, they were able to reduce their break-even price for a balanced budget. The 

other way these countries became less vulnerable was 

by saving their wealth rather than squandering it. For 

example, UAE’s sovereign wealth fund in 2013 was 

$773 billion, or a massive 190 percent of GDP. 

Of course, many of the OPEC countries have spent 

lots of money on national development plans and 

extensive welfare systems. As a result, a country like 

Saudi Arabia is now running a budget deficit, but the 

Saudis have $753 billion in reserves to cover government spending commitments for almost 3 years. Similarly, Kuwait has $548 billion in reserves and assets 
18

to stem the tide. However, Kuwait is less threatened 

by low oil prices because its fiscal break-even price 

for a balanced budget is so low—circa $60 a barrel. 

The point is, all the countries can weather the storm of 

low oil prices for a prolonged period of time with no 

ill effects. 

Admittedly, Bahrain and Oman—two of the smaller, more financially modest GCC states—have a more 

difficult time with the low oil prices. However, both 

of them have up to a $10 billion line of credit with the 

GCC if they need it. Bahrain and Oman are also using the low oil price environment as an opportunity 

to rein in their fiscally wasteful fuel subsidy systems. 

Oman has doubled its gas prices and Bahrain also has 

plans to reduce fuel subsidies. 

Iran is another Mideast country vulnerable to low 

oil prices. Iran’s break-even price for a balanced budget was $125 a barrel. With oil prices currently under 

$50 a barrel, Iran has been struggling to balance its 

budget. To make matters worse, Iran is still facing 

sanctions that limit both the quantity of its exports 

as well as access to credit. Its foreign exchange rate 

has plummeted, which makes its imports even more 

expensive. As a result, Iran is also burning through 

its foreign reserves. How much? The good news (for 

Iran) is that Iran has diversified its economy and now 

depends less on oil. A weaker exchange rate will also 

stimulate these nonoil exports.

Finally, what if low oil prices remain relatively low 

for 5 years or longer?41 This could happen if the U.S., 

Canadian, and Brazilian unconventional extraction of 

oil keeps accelerating, sanctions against Iran continue, 

OPEC refuses to cut its production, and all the major 

economies in the world go into an extended period of 

deflation and recession. Libya and Iran, already in bad 
19

shape, would get worse. Iran might follow Libya into 

civil war. Qatar and UAE would exhaust donor aid 

and see their budget deficits rise. The Saudis, UAE, 

and Kuwait would be the last to feel the heat, but even 

these three countries would face rising social unrest. 

During the last Arab Spring, petro-states stayed 

politically popular at home by dipping into their budget surpluses in order to placate their potentially rebellious populations with lavish social spending. That 

kept any internal protests manageable. The “perfect 

storm” would be for a future Arab Spring style societal 

disruption to occur after the petro-states have used up 

their oil stabilization funds, sovereign wealth funds, 

and GCC loans offsetting financial losses from low oil 

prices. At this point, many of the petro-states would 

be saddled with high budget deficits and thus lack the 

ability to use social spending again to placate their potentially rebellious populations. That will make social 

unrest and political instability even more likely. While 

the chances of the confluence of all of these negative 

factors happening simultaneously is remote, this perfect storm cannot be ruled out. At the end of this Paper, I recommend an early warning system (EWS) of 

last resort to address this social, political, and financial 

nightmare. 

PART IV. IMPLICATIONS FOR THE 

WIDER CENTRAL REGION

We have now explored the international oil market 

as a whole and compared and contrasted the impact 

of low oil prices on the producers of oil in the United 

States and the Central Region. In other words, we 

looked at the oil suppliers, but what about the countries in the Central Region that are net importers of the 
20

oil? As a group, do these buyers offer any signs of a 

demand response to low oil prices? The short answer 

is that these net importers of oil in the Central Region 

behave much like their counterparts in the rest of the 

world. That is because the usual benefits of lower oil 

prices—such as increased household disposable income and reduced input costs—have been largely offset by weak underlying economic conditions. 

If we break down the economic factors of this net 

oil importing group, the rise of Daesh has disrupted 

traditional trade routes and caused economic growth 

to plummet in many of these countries. Internally displaced people and refugees have also been a burden 

on many of these countries. Many of these countries 

have also increased taxes to pay for higher military 

spending to fight Daesh. That equates to less purchasing power for oil for consumers in these net oil 

importing countries. 

In addition, these countries share the same behavior of many of their net oil importing counterparts in 

the rest of the world. Their weak foreign exchange 

rate against a strong U.S. dollar at least partially dilutes some of the benefits of importing oil at lower 

prices. In addition, oil producers have less income and 

tend to buy less from these net oil importers as a result. Oil producers like Russia also have less money to 

pay for guest workers from Central Asia. They either 

send the guest workers back home to Central Asia or 

they cut their wages. Either way, these countries have 

less money to spend on oil. Finally, subsidy cuts and 

mounting deflationary concerns, like the other factors mentioned, have kept the demand for oil weak 

thus far. We will drill down in these two areas in 

the succeeding pages. 
21

Of course, no two countries in the Central Region 

have exactly the same problems. As a result, some 

countries benefit more from low oil prices than others. Countries most dependent on oil imports gain the 

most from low oil prices. The cost of their oil imports 

fall, thus improving their balance of payments. 

On the international front, lower oil prices helped 

to improve the terms of trade of net oil importers. 

Many were financially vulnerable because of their 

high current account deficits and their weak foreign 

exchange rates. In essence, low oil prices are an involuntary transfer of financial resources from oil producers to formerly financially vulnerable countries cited 

previously. That enhances financial stability of these 

countries in their balance of payments. 

Even so, what is the impact of low oil prices on 

the fiscal balance sheets of some of the financially vulnerable net oil importers? For starters, many of these 

countries have previously been running high budget 

deficits because of high fuel subsidies when oil prices 

were high. Lower oil prices provide net oil importers 

a golden opportunity to slash fuel subsidies. 

Egypt has taken full advantage of these opportunities. Egyptian President Abdel Sisi has pushed 

through cuts in fuel subsidies—steps no previous 

Egyptian government dared to make—and is planning to do more. Cheaper oil, therefore, serves to 

make otherwise painful subsidy cuts less risky. These 

economic reforms paved the way for GDP to rise with 

such a boost that Egypt’s GDP was almost 7 percent in 

the 4th quarter (September-December) just as Sisi confronts an Islamic opposition that is trying to exploit 

socio-economic unrest. On the monetary side, low oil 

prices are also beneficial and helped Egypt reduce inflation from 11.8 percent in October to 10.1 percent in 
22

December 2014. Lower inflation in turn afforded the 

Central Bank of Egypt (CBE) an opportunity to announce a 50-basis-point cut in interest rates on January 15th to support growth. The move was the first 

change in interest rates since the CBE implemented a 

100-basis-point increase in July 2014.

In contrast, Pakistan is struggling with fuel shortages. The banks recently refused to extend further 

credit to Pakistan State Oil (PSO), the state-owned fuel 

importer, to pay for imports beyond its existing credit 

of $2 billion. PSO has also failed to collect money it 

was meant to receive from privately run electricity 

generation companies, who in turn are owed large 

payments by government-owned power distribution 

companies. This long-standing fuel problem in Pakistan became a crisis when the Pakistan government 

made the mistake of trying to maintain tight control 

of spending on oil imports to keep within spending 

limits agreed to with the IMF under a loan program.

PART V. WINNERS AND LOSERS OUTSIDE THE 

CENTRAL REGION

While this Paper focuses on the U.S. oil producers 

and oil producers in the Central Region, low oil prices 

have also had an impact on other countries around the 

world. If we look north, it is clear that Canadian oil 

producers face similar problems as U.S. oil producers. Like the weak U.S. shale producers, over half of 

Canada’s total oil production now comes from costly 

Canadian oil sands that are at risk from low oil prices. 

In fact, Canadian oil sand producers have some of the 

world’s highest energy production costs. Estimates 

put the break-even cost for Canadian oil sand producers between $75 and $85 a barrel. Lower prices, there-
23

fore, dent profits. That forces some operators to cut 

back on spending plans and put new projects on hold. 

As in the United States, larger operators can absorb 

lower profit margins by spreading risk among their 

global operations. In addition, the impact of the fall 

in global oil prices on Canada has been softened by a 

stronger U.S. dollar and a lower differential between 

the price of cheaper Alberta crude oil and U.S. West 

Texas Intermediate (WTI) crude oil. 

If we look south, we see that Mexico has a diversified economy and is less vulnerable to low oil prices. 

Even so, its oil output has declined, and it is now 

opening up its economy to foreign direct investments 

to increase its oil production. Its problem is timing. 

A low oil price environment normally discourages oil 

discovery and exploration. Thankfully, Mexico has a 

hedging strategy and an oil stabilization fund to protect its budget, but a prolonged period of low oil prices 

could eventually hurt Mexico as well.

If we look further south, Venezuela appears to be in 

the worst shape of all the OPEC countries reeling from 

low oil prices. It has a break-even oil price for a balanced budget of $100 a barrel, in part because of huge 

fuel subsidies that result in gas prices at the pump of 

only 5 cents a gallon, the cheapest in the world. With 

oil prices currently half that amount, the government 

is struggling to make ends meet, but there is not much 

hope in the short run. The government made no attempt to diversify and now is 95 percent dependent 

on oil in its one trick pony economy. Not surprisingly, GDP is contracting at 2.5 percent and its inflation 

rate is 60 percent. To make matters worse, it has only 

$20 billion left in reserves to balance its payments. In 

early-December 2014, Venezuela’s President Nicolas 

Maduro finally cut government spending by 20 percent. Unfortunately, it is too little, too late. 
24

Of the three major countries (the United States, Canada, and Brazil) responsible for the oil surge and subsequent oil glut, Brazil is arguably the least vulnerable 

to low oil prices. Brazil’s Petrobras officials claim its 

offshore deep-water pre-salt oil is profitable anywhere 

within a range of $41 to $57 a barrel. That said, even 

Petrobras would also find it tricky at times to sustain 

its discovery and exploration in a prolonged period of 

low oil prices. As for Argentina, its economy has struggled with an inflation rate of 38 percent in 2014. The 

good news is that Argentine consumers certainly benefit from lower priced oil imports. The bad news is that 

Argentine businesses are hurt by low prices for their 

food exports. 

While this Paper has focused on OPEC countries 

in the Central Region, there are plenty of non-OPEC 

oil producers that are also at risk from low oil prices. 

Russia is arguably the most at risk. It made no attempt 

to diversify its one trick pony economy, so it now 

almost totally depends on oil. In addition to low oil 

prices, Russia’s aggression in Ukraine means it also 

has to struggle with economic sanctions. Not surprisingly, Russia is now reeling from rising budget deficits, a weak ruble, and a 4 percent contraction in GDP. 

Fortunately for Russia, it has a financial buffer—$430 

billion in reserves to balance its payments. Nevertheless, any prolonged period of low oil prices would put 

even this financial buffer at risk. 

If we move west of Russia, we see that low oil 

prices are more of a mixed bag for Western Europe. 

West European consumers benefit from low oil prices. 

However, a weak Euro foreign exchange rate against 

the strong U.S. dollar dilutes some of the benefit of 

importing lower priced oil. In fact, Western Europeans are not getting enough of a boost from low oil 
25

prices to overcome the recent IMF downgrade of their 

prospects for GDP growth in 2015. In addition, the EU 

used to be a big oil producer. However, EU oil production has fallen by 50 percent since 2002. The EU 

now imports 85 percent of its oil supply. 

Interestingly enough, Norway’s problem is similar 

to Mexico’s problem: falling oil output. It must shift 

its focus from the North Sea and the Norwegian Sea 

to the more promising Barents Sea. Unfortunately, the 

low oil price environment is already causing Statoil to 

delay the Johan Castberg discovery and to cut spending plans on other costly projects as well. That said, 

Norway is still in relatively good shape with a breakeven price for a balanced budget and an $838 billion 

sovereign wealth fund to ride out low oil prices for 

a while.

If we “pivot” to Asia-Pacific, we see that Australia 

is a major commodity exporter when it comes to iron 

ore, coal, and liquefied natural gas, but a net importer 

of oil. Unfortunately, the rise of U.S. energy production and China’s economic slowdown has significantly 

contributed to Australia’s falling commodity exports, 

thus worsening Australia’s current account deficit in 

its balance of payments and pushing down the Australian foreign exchange rate against the U.S. dollar. 

On the positive side, cheaper imported oil is a boost 

to household spending power in Australia. In fact, 

cheaper imported oil prices have already benefitted 

Aussie consumers to the tune of $2 billion to $3 billion. 

That said, a weaker Australian foreign exchange rate 

dilutes some of the benefits of cheaper imported oil. 

If we head north, we see that Japan, like the EU, 

is a net oil importer. As a result, Japanese consumers benefit from low oil prices. However, like the EU, 

the weak foreign exchange rate of the yen against the 
26

strong U.S. dollar also dilutes some of the benefit of 

importing lower priced oil. And like the EU, Japan is 

not getting enough of a boost from low oil prices to 

overcome the recent IMF downgrade of its prospects 

for GDP growth in 2015. 

In addition, the Bank of Japan (BOJ) and the ECB 

were planning to roll out large quantitative easing programs to fight off deflation, but now lower oil prices 

are already deflating prices. Will low oil prices derail 

the BOJ’s and the ECB’s plans to counter deflation? 

That depends on how long low oil prices will last. If 

oil prices remain low and the BOJ and the ECB dither, 

low oil prices could accelerate deflationary pressure 

already weakening GDP in Japan and the EU. At a 

minimum, the uncertainty over how low oil prices 

will go and for how long complicates monetary policy 

at the BOJ and the ECB. 

China is also ambivalent about low oil prices. 

On the one hand, China has been trying to move its 

economy from an over-reliance on exports and investments and towards a more balanced economy that 

puts more emphasis on consumer spending at home. 

However, China is the fourth biggest oil producer in 

the world and low oil prices result in less revenue for 

the government. China’s inflation rate is just 1.6 percent, close to a 4-year low. If oil prices continue to remain low, the Chinese central bank would soon share 

the same concerns about deflation as the BOJ and 

the ECB.

Finally, Africa is another region affected by low 

oil prices. For instance, Libya is especially vulnerable 

to low oil prices. Libya’s fiscal break-even price for a 

balanced budget is $111 a barrel, one of the highest in 

OPEC. With oil prices currently half that price, it will 

not take long for Libya, an OPEC country plagued by 
27

civil war and now saddled with the cost of two rival 

governments, to burn through its $104 billion in reserves. Nigeria is another African country negatively 

affected by low oil prices. Because of instability, corruption, and policy uncertainty, Nigeria faces a double 

whammy: stagnant oil production plus low oil prices 

for this smaller amount of oil. As a result, revenue has 

plummeted, and Nigeria has been forced to lower its 

oil price assumption to $65 for its budget.

CONCLUSION

If we look at the global oil market from a U.S. 

perspective, it is clear that it costs more for shale oil 

producers in the United States than for conventional 

oil producers in Saudi Arabia. The challenge, therefore, is the sustainability of this U.S. output. For their 

part, almost all U.S. shale oil producers put on a brave 

face. They claim there will be no actual reduction in 

U.S. shale oil production. However, it is fair to say 

that some U.S. shale oil producers will find the low oil 

price environment more threatening than others. 

In any event, it stands to reason that the rate of 

growth in shale oil output will at least slow down the 

longer the low oil price environment continues. In 

fact, as we have seen, some U.S. shale oil producers 

are already scaling back their spending plans for additional drilling. Therefore, we can expect a slower rate 

of growth in U.S. shale oil production even if there is 

no actual reduction in U.S. oil production. In essence, 

U.S. shale oil producers are in a de facto price war 

with the Saudis. At the November 2014 OPEC meeting, the Saudis persuaded the rest of OPEC not to cut 

production. The Saudis are betting that low oil prices 

are more threatening to the upstart U.S. shale oil pro-
28

ducers than to their national budget and those in the 

rest of OPEC. In other words, the Saudis feel they can 

price U.S. shale oil producers out of the market. 

Are the Saudis right? The amazing growth rate of 

U.S. shale oil producers will likely slow down. However, U.S. shale oil producers are “hard-core” and appear committed to maintaining their production gains 

and market shares of the past few years. They will fight 

to avoid any actual reversals in these gains. That said, 

there will be casualties as in any war. Bigger, more efficient U.S. shale oil producers will force out or absorb 

weaker U.S. producers, but this “creative destruction” 

happens every day in America’s free market.

In 2015, upward pressure on oil prices from the 

drop in oil rigs, the fall in capital spending, etc., will 

slowly but steadily lead to a slowdown in the amazing 

growth of U.S. oil production. Even so, there is unlikely to be any sharp reduction in U.S. oil output that 

would cause oil prices back to their mid-2014 peak. 

That is because it takes time to unwind the surge of 

ongoing U.S. oil production, which is at a 31-year 

high. Commercial oil stocks now have a 44-day inventory, the highest level since 1931. Downward pressure 

comes from signs of a growing market in floating storage. The steeper curve from the low spot market price 

to the higher future market price also attracts Wall 

Street traders to opt for “contango,”42 or arbitraging 

crude oil. This “storage play” involves buying oil at 

low prices in the spot market and putting it into storage, while, at the same time, selling a forward derivative contract (at a higher price) to lock in a profit. All 

of this prolongs the sell-off. 

In the short term, expect price volatility from a 

market that reacts up or down to every buy or sell signal. By the second half of 2015, upward pressure on 
29

prices will gain momentum and strength. Rebalancing the oil market may begin to occur in the second 

half of 2015, but the market is not likely to clear until 

2016. However, this rebalancing does not necessarily 

equate to the status quo ante. Quite the contrary, it is 

clear that the market is exploring uncharted waters. 

The oil market is undergoing both a historic structural 

change with new technology (from unconventional 

extraction of oil) as well as a cyclical change.43

In addition, this analysis shows that countries 

that refused to diversify their economies are the most 

vulnerable to a low oil price environment. Those oil 

exporting countries like Saudi Arabia, which took 

advantage of high oil prices to create oil stabilization 

funds or sovereign wealth funds, are not threatened 

by the current low oil price environment. They can tap 

into these financial buffers to stabilize their economies 

and ride out the low oil price environment without 

much difficulty. U.S. companies are in a weaker position, but they can still compete with the Saudis by using profits from their global operations to offset losses 

in their shale oil operations. They can also benefit from 

mergers and acquisitions of smaller and weaker companies with more localized operations. Finally, this 

analysis shows that populism is a recipe for financial 

disaster. Populist countries that squander wealth with 

fuel subsidies have no way to cope with a low oil price 

environment. 

RECOMMENDATIONS

At a time when the United States is seeking cooperation with Saudi Arabia and the rest of the GCC to 

counter Daesh, the United States and Saudi Arabia are 

in a bitter price war. The Saudis feel they can price 
30

U.S. shale oil producers out of the market. U.S. oil 

companies are responding. The coalition will fail if 

the United States and the GCC are determined to run 

each other’s oil companies into the ground. A successful wartime alliance will fail if it rests on a reservoir of 

U.S.-Saudi animosity and resentment in the oil market. The time to set up institutions to avert these price 

wars or to create energy banks to mitigate them when 

they come is long overdue. 

At the World Economic Forum, Total CEO Patrick 

Pouyanne said Total is scaling back its oil operations. 

As Pouyanne put it, “I can come back in 1 year—when 

prices come back.”44 That may work for Total, but a lot 

of oil companies will be out of business in 1 year unless 

they get some help. In this regard, Eni CEO Claudio 

Descalzi says the main problem is the availability of 

financing for these oil companies fighting for survival. 

Descalzi recommends a central bank for oil to stabilize 

oil prices and avoid boom and bust cycles.45

Descalzi makes a persuasive case on the need for 

such a bank as a lender of last resort for oil companies. 

However, a reactive bank that bails out oil companies 

in distress is not all that needs to be created. What 

also needs to be created is an international oil institution that is pro-active as well. Why is this necessary? 

If a tropical storm begins to gather hurricane-level 

strength off the coast of Florida, the Federal Emergency Management Agency warns us. If a ballistic missile 

is launched somewhere in the Middle East, a shared 

EWS can immediately alert affected nations while that 

missile is still airborne. But if a global oil crisis is lurking around a corner and threatening the U.S. oil industry . . . nothing happens. 
31

Instead of a triggered warning that allows for 

avoiding catastrophic consequences, the oil crisis 

simply hits oil companies, taking down countless individuals’ livelihoods with it. If the current threat to 

U.S. energy companies has taught us anything, it is 

that we need an international energy EWS that can 

alert policymakers to pending financial crises in the 

international oil industry. In large part, the failure of 

our global financial institutions to sound alarm bells 

well before the boom and bust of U.S. oil companies 

is the result of a flawed mind-set that says this time is 

different. 

Failing to give credence to the commonalities of oil 

crises, economists and institutions of this mind-set instead conclude that we cannot predict crises because a 

different, exceptional factor is in play each time. That 

has left the International Energy Agency (IEA) and 

other organizations reacting to, rather than trying to 

avert, crises. In contrast, many economists and institutions have been able to predict and warn of recent 

economic crises. Their alarm flowed from their use of 

a “signals approach.” They looked at numerous financial crises in the past 2 decades and saw disturbing 

early signs of financial vulnerability common to all of 

them. Most importantly, they saw many of these same 

financial risks that lead to boom and bust cycles.

The same EWS is even more urgently needed now. 

Fortunately, IEA does offer general warnings. Even 

so, a much greater shift toward a signals approach 

and toward a more comprehensive EWS is needed in 

the international energy industry. 

• An oil EWS would monitor economic indicators that history reveals are precursors of boom 

and bust oil cycles.
32

• An oil EWS would take into account extenuating economic circumstances and political factors that affect energy risk. Qatar’s large public 

borrowing requirements, for instance, would 

be considered a dangerous economic indicator 

if we did not also factor in the Qatari government’s investment in doubling the production 

and export of liquid natural gas.

By accounting for all these indicators and factors, 

an EWS would identify a coherent story line of rising 

financial vulnerability for oil companies where appropriate. Each economy’s circumstance is different, 

but there are commonalities that allow us to be more 

effective in predicting oil crises. By communicating 

simple but comprehensive story lines to policymakers, an oil EWS would do more than simply ring alarm 

bells. Economies generally crash in the same fashion 

as dominos fall. By identifying key factors and decision points along the way as economic trends unfold, 

an energy EWS would provide guidance—allowing 

policymakers and oil companies to work together 

to change the alignment of dominos, as it were, and 

avert financial crises. For instance:

• An oil EWS would encourage U.S. oil companies to diversify their product lines so they 

could become less vulnerable to low oil prices. 

The role models are Chevron and Exxon Mobil. They have refining and chemical businesses 

that provide financial buffers to offset financial 

losses in oil production when oil prices are low.

• An oil EWS would also encourage net oil importing countries to take advantage of the opportunity to reduce their fuel subsidies in order to strengthen their fiscal balance sheets. For 
33

those net oil importing countries that have already eliminated fuel subsidies, now is a golden opportunity to redirect financial resources 

into the education and training of their domestic workforce and boosting national savings.

We have the historical knowledge needed to implement an energy EWS—most logically at the IEA. 

However, we need economists who know their financial history and who are committed to a “signals approach” rather than economists who keep saying “this 

time is different.” Nothing short of a wholesale culture 

change in our global financial institutions is required, 

one that recognizes that the urgency of the times demands an early warning of oil crises—and that we are 

capable of providing it.

ENDNOTES

1. That said, inflation is still a problem in a few isolated emerging market economies. 

2. Some of this weak demand also reflects more efficient factories, which require less energy to run them. Demand for oil is 

also relatively weak because trucks, buses, and ships have shifted 

to natural gas and other alternatives.

3. Nicole Friedman, “Oil’s Descent Deepens as Demand Fears 

Grow?” The Wall Street Journal, September 11, 2014.

4. Jesse Colombo, “Nine Reasons Why Oil Prices May be 

Headed for a Bust,” Barrons, June 9, 2014.

5. Ed Crooks, “US Shale: What lies beneath,” Financial Times, 

August 26, 2014.

6. Ibid. 
34

7. Friedman, “Oil’s Descent Deepens as Demand Fears 

Grow?”

8. Ibid. While China is still growing at 7.4 percent, that is a far 

cry from China’s double digit growth in the past.

9. Colombo.

10. Ibid.

11. Ibid. 

12. Nicole Friedman, “Oil Prices Tumble as Demand Flags,” 

The Wall Street Journal, August 13, 2014.

13. Ibid.

14. Ibid.

15. Ibid.

16. Average GDP growth in the Eurozone in 2014 was below 

1 percent (0.8 percent). GDP growth in France (0.4 percent) and 

Italy (0.4 percent) pulled it down and GDP growth in Germany 

(1.4 percent) and Spain (1.3 percent) lifted it a bit. See The Economist, February 7, 2015. However, the International Monetary Fund 

(IMF) said there was a good chance that the German economy 

would contract in 2015. 

17. For an alternative view that geopolitical upheavals could 

drive oil prices up in the future, see Anjli Raval, “Oil Investors 

Bet on Future Supply Risks,” Financial Times, August 21, 2014. 

Another factor that could put upward pressure on prices in the 

future is the oil skills shortage. See Guy Chazan, “Terrifying Oil 

Skills Shortage Delays Projects and Raises Risks,” Financial Times, 

July 16, 2014.

18. Not to be outdone, Iraqi oil production surged to a 35-year 

high despite the war against Daesh. Neil Hume, “Oil advances on 

U.S. slowdown hopes,” Financial Times, February 2, 2015.
35

19. Neil Hume, “BIS Says Financial Flows Partly to Blame for 

Oil Collapse,” Financial Times, February 7, 2015.

20. Anjli Raval, “Oil Rallies as Producers Cut Drilling and 

Spending,” Financial Times, February 6, 2015.

21. See Gregory Meyer and Anjil Raval, “Brent Crude under 

$50 a Barrel,” Financial Times, January 7, 2015.

22. International Energy Agency (IEA) Report, January 

16, 2015.

23. Ed Crooks, “Discoveries of New Oil and Gas Reserves 

Drop to 20-Year Low,” Financial Times, February 15, 2015.

24. Christopher Adams and Michael Kavanagh, “BP Chief 

Warns of Oil Industry Slump,” Financial Times, February 3, 2015.

25. Jamie Smyth and James Wilson, “BHP Cuts Shale Investment Amid Drop in Oil Price,” January 21, 2015.

26. Neil Hume, “Crude Climbs as Oil Majors Cut Spending,” 

Financial Times, February 3, 2015.

27. Christopher Adams and Michael Kavanagh, “Oil Projects 

Worth Billions Put on Hold,” Financial Times, January 14, 2015.

28. Anjli Raval, “Oil Rallies as Producers Cut Drilling and 

Spending.”

29. Andrew Hill, “Davos 2015: Oil Chiefs Feel Chill Wind of 

Uncertainty over Price,” Financial Times, January 21, 2015.

30. Ibid. 

31. Christopher Adams and Ed Crooks, “Battered Energy Groups Brace for Spending Cuts,” Financial Times, January 

25, 2015.

32. See Sandile Tshazibana, “Oil’s Collapse May Fuel the Next 

Financial Crisis,” February 1, 2015.
36

33. John Authers, “Cost of Cheap Oil on U.S. Earnings

 Revealed,” Financial Times, January 30, 2015.

34. Gillian Tett, “Finance Can Cope with Cheap Oil,” Financial 

Times, January 15, 2015.

35. Ibid.

36. Ibid.

37. Ibid. 

38. See Yaroslav Trofimov, “Analysis: Oil Price Drop Adds 

New Element to Middle East Tensions,” The Wall Street Journal, 

December 2, 2014.

39. Adams and Kavanagh, “BP Chief Warns of Oil Industry 

Slump.”

40. This research contrasting the low capital spending by 

U.S. oil companies such as Schlumberger, Halliburton, and Baker Hughes versus high capital spending by Saudi oil producers 

comes from Ed Crooks, “Impact of Oil Price Rout Starkly Evident 

in North America,” Financial Times, January 22, 2015.

41. See Brenda Shaffer, “How Plunging Oil Scrambles Geopolitics,” The Wall Street Journal, October 30, 2014. 

42. Contango is a situation where the futures price (or forward price) of a commodity is higher than the expected spot price.

43. IEA.

44. Crooks, “Impact of the Oil Price Rout Starkly Evident in 

North America.” 

45. Andrew Hill, “Davos 2015: Oil Chiefs Feel Chill Wind of 

Uncertainty over Price,” Financial Times, January 21, 2015. 
U.S. ARMY WAR COLLEGE

Major General William E. Rapp

Commandant

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STRATEGIC STUDIES INSTITUTE

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U.S. ARMY WAR COLLEGE PRESS

Director

Professor Douglas C. Lovelace, Jr.

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