OPEC Thoroughly Fracked
It’s been two years since Saudi Arabia and OPEC decided to strike a blow against the upstart shale oil drillers in the U.S. Over the previous six years the U.S. had increased domestic crude oil production by nearly five million barrels per day, and OPEC was starting to lose market share.
Mind you, OPEC hadn’t lost a huge amount of market share. Because global demand for crude was growing, OPEC’s share of global production had only declined from about 43% to 41%.
But perhaps the oil exporters were hoping to avoid a repeat of what happened in the wake of the 1973 oil embargo, which led to a major loss of market share for OPEC:
OPEC’s market share peaked in 1973 at 51% of global crude oil production. By 1985 it had fallen to under 28% as a result of new discoveries outside of OPEC and conservation measures adopted in the West in the wake of the oil embargo. But then over the next decade OPEC managed to claw back some of the lost market share, reaching 40% of global production in the 1990s and remaining around that level until the present.
Yet U.S. production since 2008 had been growing at the fastest rate in history, and OPEC decided to attempt to stem that tide. In November 2014 it said members would defend market share against competitors, and then over the span of two years OPEC boosted production by 1.8 million bpd, exacerbating the surplus caused by the shale oil surge in the U.S.
Based on statements made by OPEC members at the time, they clearly expected oil prices, which had already declined to ~$75/bbl, might fall to $60 or even $50/bbl. It was commonly believed that $60 oil would decimate the U.S. shale oil industry, so after weathering this brief period of “low” prices, OPEC would be back in the driver’s seat.
I have argued that this was a strategic mistake on OPEC’s part, destined to cost exporters a lot of money without a strong likelihood their gambit would succeed.
I was right about that. U.S. shale oil production proved much more resilient than expected. Some producers did go bankrupt, and U.S. production did fall. But most producers slashed expenses and kept producing (although they mostly stopped drilling new wells.) The result was that prices plunged much more than OPEC expected, and this inflicted deep financial pain on its members.
At subsequent OPEC meetings, there were always comments from Venezuela or Nigeria that production cuts were needed to prop up prices. Yet each time, the outcome of the meeting was to maintain course.
OPEC has tried to talk the price of oil up on several occasions since, but the markets kept watching global inventories climb higher and higher. Lip service could not maintain the price of oil where OPEC wanted it, so last week the group announced a change in strategy, tentatively agreeing on the first production cuts since 2008.
OPEC plans to reduce its output by as much as 740,000 bpd, to 32.5 million bpd. This decline would be on top of approximately 1 million bpd of oil production curbed in the U.S. over the last year, so if OPEC follows through — and given enough time — this could go a long way toward restoring balance in the markets.
The markets took this news a bit more seriously than previous attempts to talk up the price, with Brent crude rising 6%. But global crude oil inventories are still quite high, so it is going to take some time to bring them back to normal historical levels.
As those inventories decline and prices creep higher, there are quite a few drilled but uncompleted (DUC) shale oil wells ready to come online. That will provide some resistance to further price increases. The bottom line is that you shouldn’t expect OPEC’s action to bring about a quick recovery in the oil patch.
The strong growth trajectory of U.S. shale production was halted by OPEC’s moves in 2014, but as a result of the lower prices producers were forced to become more cost efficient. Break-even costs fell, and ~80% of U.S. shale oil remains online.
Shale oil is not going away as easily as OPEC imagined. Production won’t grow as rapidly as it did before, and OPEC can claim credit for that. But this is undoubtedly not the outcome OPEC envisioned in 2014 when it opted to defend market share.