Race to the last barrel
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On the one hand is OPEC which, with a cut in crude oil production, attempts to support the price increase and, on the other hand is the new rise in U.S. shale oil output, which has become cheaper. Who will win market dominance?

Oil is a global market. Prices are determined mostly on international exchanges or via contracts that are based on international pricing via the exchange plus transport and other costs, which are usually minor compared to the overall value of the cargo. There are many types of oil. U.S. shale oil is mostly light, sweet crude. OPEC oil comes in many varieties from light, sweet crude oils from Libya and Kuwait to very heavy, sour oils from Venezuela. Some countries, such as Saudi Arabia and Iran have many different types of oil depending on the fields it is produced from. OPEC crude oil is often not of the same type as shale oil. So why, one might ask do we consider shale oil in competition with OPEC oil? It is clearly more in competition with the light, sweet crudes from OPEC countries that produce such oils, most particularly since the U.S. ended its ban on the export of crude oil to most countries. Before the relaxation of this ban the main effect of the huge ramp up of U.S. shale oil from 2006 to 2014 was to displace imported oil into the U.S. of the same varieties, and also to displace imported oil to the refined for use in the U.S. or to be exported from the U.S. U.S. exports of refined products skyrocketed as shale oil production in the country ramped up. The oil companies and others needed to move the increased oil production some way – even with a ban on most exports of crude oil, exporting of refined products was allowed. So to make money the companies exported the refined products. Many U.S. refineries are set up not for light, sweet crude, but for heavier and sourer varieties. So there was further displacement of the heavier and sourer varieties from OPEC and non-OPEC oils imported into the US by blending these varieties with shale oil in order to make the mixture work in U.S. refineries.

The new advance of the United States

As the U.S. increased production from early 2006 to the drop off in oil prices in 2014 by nearly 4.5 million barrels per day, and most of this was shale oil, all OPEC producers combined increased their production by less than the U.S. at about 3.5 million barrels per day.
The most important reason behind the precipitous drop in oil prices globally was the increase in production of shale oil in the U.S., which now is over 50 percent of all oil production in the U.S. Saudi Arabia’s increase during this time was just 2 million barrels a day. Many OPEC countries, such as Libya, Algeria, Venezuela, and Qatar saw drops in their production over this time period. The greatest increase in production in OPEC countries over that time period was in Iraq, not Saudi Arabia, but it was just around 2.5 million barrels a day. Since the harsh price collapses in 2014 and 2015 OPEC countries seem to have been trying to slow down shale production in the US by upping their production in order to cut the average prices of oils to below costs for shale oil producers in the U.S. Shale production in many fields in the U.S. continued to grow, such as in some Permian Basin fields. Others had to shut down due to massive debts and even bankruptcy. However, during this difficult period of low oil prices facing the shale oil producers these shale producers saw their costs of exploration and production drop from the lack of demand for the resources, technologies, machines and labor needed to explore and producer. Many of these companies also successfully cut costs by finding where they could cut costs -- and they just did it.

A countertrending energy scenario

Costs for producing oil in the shale fields of the U.S. have dropped. The Bakken fields on average dropped from breakeven price of over $60 per barrel in 2013 to just under $30 in 2016. During the same time period Eagle Ford production prices dropped from about $80 to about $40, Niobara field production dropped from about $70 to under $40, many Permian fields dropped from about $80 to less than $40. Cost cutting has been severe and successful in many cases. Shale oil is becoming more competitive. Oil field breakeven prices in many Middle Eastern countries are lower than in U.S. shale fields, but their government breakeven budget prices for oil are far higher than the oil field break even prices for shale fields. Many OPEC budgets are based on these breakeven oil prices. Saudi Arabia’s, Oman’s and Algeria’s are between $80-100. Saudi Arabia has been able to cut its breakeven oil prices down due to budget cuts and other measures, but it is still much higher than the present and reasonable near term expected prices of oil. Iraq and Iran are in the $70-80 range. Of all of the Middle Eastern oil producers only Kuwait’s budget breakeven price is even near the current price of oil on average. So the effective breakeven price of oil in many OPEC countries given their budgetary and economic constraints is well over that of the field breakeven prices for shale oil producers in the U.S. This is not just a competition across types of fields and types of oils, but also across where the oil revenues go to. If one’s country needs a very high price of oil to have a breakeven budget that constrains that country’s behavior to try to keep the price of oil high. Shale producers in the U.S. and the U.S. government do not have that problem. The ties between oil production and government budgets and export revenues are much stronger in OPEC states than in the US.

Shorter shale oil production times

Importantly, from discovery to production for shale oil is often faster than in conventional onshore and offshore fields. There are many factors involved in time from discovery to production, such as the existence or not of proper infrastructure (like pipelines) to get the oil from field to other uses, the prices of oils, the costs of production, geological and political issues, etc. but on rough averages it takes about 5-8 years for conventional offshore fields, 2-3 years for conventional onshore fields, and only about 5 months to 1.5 years for a shale oil field. A drilled, but incomplete well in the U.S. could take as little as 1-3 months to get up to production assuming some modicum or infrastructure already nearby. U.S. shale oil producers are simply more dexterous than many OPEC producers. This has been shown in the quick reaction to the even slight increase in prices due to the OPEC production cut deal of late, which is already seeming to fall apart. Add in the power of private equity capital to get some of the shale oil producers out of their financial difficulties – for a return – and the more pro-oil policies of the Trump administration then the shale oil producers could get even more powerful on the markets, and more flexible in the production methods. Relaxing some regulations, which is expected so far, could also lead to a more competitive shale oil industry in the U.S. That is they would become more competitive with OPEC and would be increasingly dogging them in the market regularly.

A gradually declining influence

OPEC does not have the power it used to have in its earlier days, even though it has most of the known conventional reserves on the planet. Its market share is hardly a monopoly at about 34%. There is already cheating on the production cut deal, and compliance is questionable in some cases. There are also the wild cards of Libya and Iran, with Libya being the biggest wild card. If they get back up to 1.3 or 1.5 million barrels a day then the effectiveness of the cuts become moot. U.S. shale and Libya, along with Iran, could nullify the OPEC cut deal in fairly short order. The most powerful player, oddly enough given the past, could be shale oil producers in the U.S. The U.S. is now an economically diversified, democratic petro-state in many ways. It is a much bigger player on the world oil markets than it was even just 10 years ago. OPEC does not have the clout to stifle this massive change no matter how they try. OPEC is a cartel facing its own entropy from within, and also from without. The building of the Dakota Access Pipeline, the XL pipeline and other pipelines in the works could allow even faster production because of the pull factors of the market being stronger when transportation of the oil is easier and faster. Banks are also more favorable to shale oil producers if they have a proven, definitive and efficient way to get their oil to the market. U.S. shale oil is here to stay, and for a long time. The discovery of a massive Wolfcamp field near Lubbock, Texas recently could be an indication of the massive amounts of oil that could still be found in the U.S. This field has 10-15 billion barrels. That is massive.

You don't know until you know

One of the credos of the oil business is “you don’t know until you know‘. There are gigantic reserves of shale oil in the U.S. The U.S. also has missive reserves of oil shale (kerogen or near oil), oil sands and more. The U.S. will likely be a big player in the world oil markets for some time. Let us remember that the U.S. dominated many oil and kerosene markets for decades during the time of J.D. Rockefeller and beyond. Some of the major sources of oil in these earlier days were to be found in the states of Ohio and Pennsylvania. The oil in the Arabian Gulf area was still unknown back then. Few even considered oil in Norway, Angola, Nigeria, and other major OPEC and non-OPEC countries that we now clearly associate with oil. Things change.
There are also massive shale oil fields that have not even been fully looked at, never mind starting to develop them, globally. There are massive global reserves of shale oil outside of OPEC countries. The competition from the U.S. shale oil fields could be just the beginning of a global shift in the centers of gravity of oil economic, politics and business away from OPEC and towards more dispersed and less combinable sources. A new era in oil has started and trying to stop it with a production cut deal that is already starting to show cracks in it seems is really quite weak, and in the long run it will prove to be ineffective. The future is already here in shale. Then there are those possible changes in transport technologies and so much more coming around the bend. OPEC seems to be like the little boy with his thumb in the leaking dike. (Although in this case they are very rich and very powerful men trying to stop economic and other forces that could overpower them rather more quickly than they might think.) It is time for them and many others to get with what is happening and start thinking about how to gain from the future, rather than trying to bring back the past.

*All opinions are Dr. Sullivan’s alone