Even if OPEC, Russia deal works as hoped, uptick in US shale production could keep prices depressed
Crude oil prices rose Friday on news that OPEC agreed to stabilize global markets. Somewhere in Riydah, Deputy Crown Prince Mohammed bin Salman is desperately hoping he can finesse prices high enough to cut Saudi Arabia’s burgeoning deficits but not high enough to fire up the mighty US shale production, which fell by a million b/d over the past two years of low prices.
At a meeting in Algiers, OPEC members “took into account current market conditions and immediate prospects and concluded that it is not advisable to ignore the potential risk that the present stock overhang may continue to weigh negatively well into the future, with a worsening impact on producers, consumers and the industry,” the cartel said in a press release.
This is a reversal for the Saudis, the most powerful OPEC player, which said only this spring that they didn’t care if prices were $30 or $70, they were no longer ceding market share to balance global oil markets.
Well, the Prince has had a change of heart. Low prices did not reduce production as much as the Saudis expected. Even though consumption grew rapidly, a huge glut of crude oil in inventory continued to depress prices, largely because OPEC members actually increased production by several million b/d and Russia also maximized output. Daily oversupply is thought to about 1 to 1.5 million b/d, according to analysts.
The impact of the new strategy will depend upon how OPEC ministers decide to slice and dice production numbers. Output will be limited to between 32.5 and 33.0 million b/d, down from the current 33.6 million b/d. At best, this is probably a freeze, not a cut, according to Reuters market analyst John Kemp.
Khalid al-Falih, the Saudi oil minister, says the deal will involve “gentle adjustments and reassurances to the market” but “it will be called a freeze but involve individual cuts,” according to the Petroleum Economist newsletter.
With oil prices hovering in the high $40 range on Friday, they seem poised to bump over the psychologically important $50 threshold in the near future. OPEC minister hope to keep it below $60, which University of Houston energy economist Ed Hirs says is the price the most efficient shale producers need to start up again.
“To get back into the flush of shale drilling activity at 2013-14 levels we will need sustained prices of $80/bbl at WTI [West Texas Intermediate]. Certainly many will come back at $60, but when we look at averages, half of the industry has been made noneconomic,” he said in an interview.
Hirs notes that many shale drillers have large inventories of DUCs (drilled uncompleted wells). The US Energy Information Administration estimates there are 4,117 in the four oil-dominant shale basins (Bakken, Eagle Ford, Niobrara, Permian).
Hirs says that with the many oil company bankruptcies and reorganizations that have occurred, the drilling costs for those wells have been written off.
“Many analysts think that these DUCs will be completed profitably at $50/b at the wellhead,” which are less than the commonly quoted Brent and WTI, he said.
In other words, OPEC’s new strategy is likely to have a minor impact on American shale production, but not enough to significantly affect output.
Assuming, of course, that OPEC members stick to the new ceiling. Hirs is skeptical they will.
“I doubt that the agreement will hold. They all cheat on their quotas and underreport their production,” he said.
“The illustration of that point is the ‘addition’ of Iranian oil had a very small impact on the market. Why? It was already in the market, just at half-price or so. Now that Iran can get $40-plus a barrel, they feel like they have a windfall.”
Russia has agreed to withhold additional production in the short-term if the Saudis follow through with their commitment, but “who among OPEC will enforce a quota agreement against Russia?” Hirs asks.
Bottom line, American and Canadian oil producers should be cautiously optimistic about the short-term impact of the OPEC and Russian new direction, if for no other reason than it signals a change of thinking among the Saudis, who have driven the price rout that began in late 2014.
Now that they’s shifted strategy, they may do so again in 2017 if the current agreement, expected to be implemented in Nov., doesn’t achieve the desired results.
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