An absolutely elemental maxim of how you can go wrong in political risk analysis revolves around what is called “The Drunken Gambler in Vegas Syndrome”. Every casino owner alive has made millions off the fallacy, just as a great number of foreign policy disasters have been forged because of it. Simply put, it lays out how terrible results – far from putting any respective gambler or policy-maker off – actually shackle decision-makers to doubling down, precisely because they have already invested so much. If Dad – unbeknownst to the rest of the family – has already gambled and lost the kids’ college savings at the tables, he will keep playing on credit, precisely because he knows he cannot go home as things stand.
This explains why casino owners tend to be very wealthy, as well as the endless American tragedy in Vietnam. So much blood and treasure had already been expended for absolutely nothing that, paradoxically, the US found it very hard to extricate itself from the war – despite the dire real world results – as that would have been to admit the scale of the calamity.
Don’t look now, but the Saudis have been sitting at (and losing on) the oil war tables for the past year. And in line with the Drunken Gambler Syndrome, they have just doubled down.
Just a year ago – in this column’s best political risk prediction of the year – we correctly gauged that Saudi Arabia was going off the reservation, neutering Opec, and attempting to drive down the price of oil, in a John D Rockefeller-style effort to retain market share and wipe the newly triumphant American shale revolution off the map. The results have been dramatic. Oil now sits, rather incredibly, at under $40 a barrel. Riyadh has at the most recent Opec meeting spurned all pleas to return to its traditional role as swing producer, steering prices to higher levels to ensure long-term stability in the oil markets.
But if the Saudi strategy has become clear, its effectiveness has not. The short-term pain for Riyadh has been immense, with the country currently sporting a budget deficit amounting to an eye-popping 20 per cent of GDP. However formidable are Saudi foreign reserves (and at $661bn at the end of September 2015, they surely are), this simply cannot go on forever. The Saudis, if they don’t change course, can continue their scorched earth policy for just under a decade, allowing for the present rate of reserve depletion. Of course, far before then, every other significant oil producer in the world would be utterly ruined, meaning that, in reality, Riyadh has much less time than this. At best, the Saudis can only double down into the medium term.
And the problem for the Saudis is that the shale cat has many lives, as the industry has proven itself endlessly adaptable. Due to its remarkable productivity gains (frackers have cut costs by 45 per cent in 2015 alone), shale has seen a decline of fully 1,000 rigs since 2014, but only recently – in October 2015 – has production started to fall. It is now estimated that shale drilling is profitable at an ever tumbling $55-60 a barrel. There is no doubt that the Saudis have miscalculated as to how long it will take their shale nemesis to crumble.
Further, shale rigs can be plugged in and re-started for a fraction of the cost of the usual fixed rigs the rest of the world operates. As such, they are the nimble mammals living in a world of fading dinosaurs. Like a light-switch, shale production can be switched on and off in response to the global price. Wholly unwittingly, as we speculated a year ago, shale (and not the Saudis) has become the new global swing producer, in essence setting a ceiling on energy prices for the foreseeable future.
So in true Kafkaesque fashion, even if the Saudis temporarily drive American shale out of the oil market, as the price then inevitably rises, so too will shale, phoenix-like from the ashes. Riyadh has been flummoxed by the price responsiveness of American shale to the ups and downs of the oil market. And what is their response to their failed policy? Given what they have invested, the Saudis have adopted the Drunken Gambler Syndrome, and are doing more of the same.
The immediate outcome of all this is easy to predict: incredibly low oil prices well into the medium term. However, the damage to oil producers across the world that the Saudis have wrought amounts to a new, and potentially virulent, global political risk problem well into the future. Sometimes it is better to just cut your losses.