Just three months ago the price of oil hung at $80 and, in spite of storm clouds on the horizon, U.S. E&Ps were planning rosy 2015 budgets. Although oil had softened by 20% in the previous three months, the price had stabilized and industry figured it had found its floor. Third-quarter operator commentaries telegraphed aggressive capex and production plans into 2015. But they were wrong.

Alas, since then, Saudi Arabia changed our worlds with the Thanksgiving surprise that it would refrain from ratcheting down production, which would support world oil prices, a role it’s assumed the past 30 years. Undisciplined fellow OPEC siblings, oil-dependent bully neighbors in Iran and Russia, and a little North American shale revolution horning into their market share was too much. Instead of playing nice, the Saudis would instead keep pumping out the volume, and let the oil hit the fan.

Of course, we all know what happened: a drowning flood of oil washed over already oversupplied global markets, not in small part impacted by the 9 MMbbl/d of production within the U.S. The price of oil collapsed by 50% from summer highs and going, last seen at $45/bbl at press time. According to Morgan Stanley, fourth-quarter profits for North American E&Ps were down 43% quarter over quarter as a result of a weak oil price environment.

If anyone still thinks the cigar-smoking conniving execs of proverbial Big Oil Companies control the price of oil, think again. The Saudis have the world by the throat. And they are happy to keep a tight grip until this all plays out in their favor.

So, with the understanding that Saudi Arabia can turn on or off the valve at its discretion, it is a clear message to U.S. producers: shut it down. The exuberance of newfound resources in shale and the optimism of energy independence via self-resourced production require a high and sustained commodity price to develop these unconventional (ie. high cost) resources.

We’ve already experienced the fallout of overproducing shale gas, bottlenecked at the borders with nowhere to go. Highs above $10/MMcf in 2008 dropped below $2 in 2009, stabilizing in a $3 to $4 window since. Shale gas enthusiasm died. Hydrocarbon-rich basins such as the Haynesville, Barnett and Arkoma Woodford became largely uneconomic to drill. Two-thirds of gas-focused rigs bolted to unconventional oil plays, with the Marcellus remaining as the last economic gas play.

Now oil follows that same path.

Optimistic operators are praying for a fast bottom and a hard ricochet upward. That might be wishful thinking. Supply is the problem and somebody—anybody, except the Saudis—must slow the flow before price will respond.

And U.S. operators have yet to send that signal. While we still anticipate a stream of fourth-quarter results and forward spending plans from said operators, most E&Ps have pre-announced that they intend to trim capex by 10%-30%, but not so much as to actually slow production—just the rate of growth. Growth declines presumably don’t play well in the marketplace.

That mentality will extend the downturn, according to Drew Venker, a Morgan Stanley analyst in a mid-January research note. “Management optimism may slow capex cuts and could keep U.S. onshore oil production flat to growing through year-end 2015,” he said. “This could prevent U.S. oil production declines until 2016, even as oil prices continue falling. While this strategy is logical, when all E&Ps expect others to reduce activity, the result is a more gradual and prolonged production response.”

Venker thinks a sub-$40 WTI price is necessary for capex shock therapy. “If WTI falls below $40/bbl and continues dropping, we believe the next round of capex cuts would be promptly announced and many E&Ps would cut activity to bare minimums, in some cases to zero drilling.”

Unfortunately, that might be necessary. As in sports, where it’s best to tend to an injury immediately than playing subpar, producers need to produce less now to reset the price of oil sooner. The reality is early 2015 cuts will only go part way, and a follow-up round will be necessary by mid-year.

Truly, the Saudis have the staying power to lop a significant portion of economic production from the fondly remembered U.S. shale revolution, and hold oil prices where they want for, well, forever, to protect their market share.

But there is good news: stuck in a sustained lower oil price environment, U.S. producers will fast-track cost efficiencies in the shale plays and learn to drill economically at much lower prices. And the Saudis will have to grasp that we’re here to stay.

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