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Crude Economics
OPEC Makes Shaky Bet on Fragility of US Shale Boom

The price of oil has plummeted in recent weeks on lower global demand and too much supply, in large part thanks to the flood of new crude supplies coming out of American shale formations. In the past, OPEC has stepped in to cut production and prevent large price drops, but not this time around. As Bloomberg reports, OPEC is betting on U.S. fracking being more vulnerable to falling prices than the cartel’s member states:

As much as 50 percent of tight oil output will be “out of the market” at current prices, while the Organization of Petroleum Exporting Countries is not in a critical situation, [OPEC’s Secretary General] Abdalla El-Badri said at the Oil & Money conference in London today.

“First of all, will be the tight oil” affected by the drop in prices, El-Badri said. “If prices stay at $85, we will see a lot of investment, a lot of projects, a lot of oil going out of the market.”

Many of the cartel’s petrostates have actually cut prices, not output, in a bid to gain market share in this bear market. By OPEC’s reasoning, low oil prices will soon force American frackers to cut shale production—a relatively expensive variety of drilling, given the hydraulic fracturing and horizontal well-drilling it requires. But as the WSJ reports, this game of chicken might not turn out so well for OPEC:

[Secretary General Abdalla El Badri’s] view is at odds with most U.S. forecasters, who say output can remain steady at current prices because companies have cut their costs by finding ways to produce oil more efficiently. For example, the amount of oil coming from each new well in South Texas has nearly doubled since 2012, federal data show.

Marianne Kah, chief economist of ConocoPhillips , said oil prices would need to fall to $50 a barrel “to really harm oil production” in U.S. shale basins. She said 80% of the American shale sector—in which ConocoPhillips is a major operator—is profitable at prices between $40 and $80 a barrel for benchmark West Texas Intermediate crude.

This is a question of breakeven oil prices, and the numbers indicate that OPEC’s members need a higher price of oil to balance their budgets than American frackers need to profitably drill shale formations. For now, the cartel seems willing to stay the course (though countries like Venezuela are decidedly unhappy with the current price of oil), but its members must be sweating bullets as they follow global crude markets. OPEC is meeting in late November, and the cartel’s ability to weather lower prices, especially as compared to the shale boom’s ability to do the same, will be top of that agenda.

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  • Thirdsyphon

    It’s not at all clear to me what the long-term purpose of this move is. Even if OPEC has the spare capacity to drop oil prices below $50.00 per barrel and keep them there (a very weird thing for OPEC to be attempting, by the way), the American frackers who are forced to shutter their operations will do so for only as long as OPEC keeps the prices artificially low. This isn’t a Walmart type situation in which competitors driven out of business by low prices are gone forever. . .the second OPEC starts trying to turn a profit again, the frackers will return with a vengeance. It’s not like ExxonMobil and BP are fragile startups with no money in their coffers to wait this process out.

    On top of that, perversely, keeping oil prices low will serve to stimulate additional demand in markets like India and China, thereby forcing OPEC to open the spigots yet further to keep prices from rising again to the point at which fracking is profitable. And sooner or later, it will be. OPEC can only subsidize the planet with cheap oil for as long as their supply of it allows. . . and that’s not going to be forever.

    I guess I just don’t see OPEC’s endgame, is what I’m saying. Shale oil resources exist, and will continue to exist, and it doesn’t much matter to the nations that own them whether they’re exploited today or 20 years from now.

    • Alex K.

      “It’s not like ExxonMobil and BP are fragile startups with no money in their coffers to wait this process out.”

      True, but shale oil is largely produced by independents, some of which are highly leveraged.

      • Thirdsyphon

        It is, and some of them are; and the subset of independents who didn’t build price hedges into their loan agreements and are running plays in more expensive fields might just end up going under as a result of this. . . but if they do, their replacement when oil prices go back up (as they ultimately will no matter what OPEC thinks it’s playing at) won’t be nobody. It will be other, larger independents or the truly global players.

  • Jacksonian_Libertarian

    I’ll put my money on the American Shale Oil producers who have already proven their ability to cut costs and increase production and will continue to do so going forward. This means a year from now American producers will have significantly lowered their break even point while the OPEC oil monopolies will likely have done nothing. It should be remembered that American Oil producers aren’t the primary support of the Government unlike the OPEC producers that are state owned monopolies who in most cases are already running in the red. Even Saudi Arabia the OPEC country in the best position needs $93 dollars a barrel to balance its 2014 Budget, which means it’s already dipping into savings with oil at $80 per barrel.

    A back of the envelop calculation: $93 – $80 = $13 x 10 million barrels per day = $130 million per day x 365 = $47.45 Billion loss for 2014 from Saudi Arabia’s $600 billion in savings. As you can see the OPEC member in the best situation is already losing about $50 billion a year, and the others are already broke (Venezuela) or soon will be.

  • LarryD

    There seems to be a confusion between the cost of *exploration* (affected by drilling costs) and the cost of *production*.

    As long as the price of oil covers the producon cost, oil will be pumped, even if exploration is paused.

    • Thirdsyphon

      Shale wells play out much faster than traditional wells do. . . which means that drilling in a shale play is a steady and recurring expense involved in production, over and above the cost of exploration.

      • Josephbleau

        you make generalizations that limit your truths. I am a director in an outfit that has been fracking gas in vertical wells near Buffalo since 1920. At low costs; Paying Cuomo level taxes.

      • PapayaSF

        $50.00 oil (or even $75.00 oil) would be a death sentence for the regimes that make up OPEC

        And Venezuela, Iran, and Russia would not be happy at $50 oil, either.

    • Alex K.

      Of course oil will be pumped from existing wells since most costs (exploration, drilling, initial fracking) are in the past (sunk) and all that remains is the lifting cost. But to maintain output, companies must drill new wells because old ones decline relatively fast – not as fast they used to in 2010 though.

  • FriendlyGoat

    OPEC just “ain’t what it used to be”—-because it can’t be.

  • rheddles

    When you’re talking Saud the Arabs, the enemy is Persia. They are getting too close to a bomb. Tomorrow is another day for oil prices. Tomorrow is being a target for the bomb.

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