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Crude Economics
Strap in for a Long Oil Price War

The trenches have been dug, the preparations (mostly) made, and now we’re in for a protracted price war between the entrenched petrostates of OPEC and the upstart producers fracking American shale. Both sides are pumping copious amounts of crude—some 1.5 million barrels per day more than what the market demands—and prices have subsequently crashed from a zenith of more than $110 per barrel last June to just above $65 per barrel today.

Saudi Arabia has strong-armed the rest of OPEC into going along with its strategy not to cut production in a bid to gain market share on U.S. shale firms, and ahead of the cartel’s semi-annual meeting next month there’s little sign that any dip in output is forthcoming. By abdicating the role of the global swing producer, OPEC believed it would put pressure on the relatively high-cost shale boom, forcing producers to trim production as certain plays became unprofitable.

But U.S. firms haven’t assumed that role as readily as the Saudis would have hoped. Rather, they’ve been hard at work innovating their way to profitability even at $65 per barrel. True, shale growth is expected to slow this year and the next, but it isn’t going away. Combine that with production growth from other non-OPEC producers, and what the cartel is left with is a longer-term price war than it likely bargained for. The WSJ reports:

Russia’s output jumped an unexpected 185,000 barrels a day year-on-year in April and Brazilian production was up 17% in the first quarter, the IEA said. Meanwhile, production in China, Vietnam and Malaysia has also shown persistently strong growth. The IEA expects Chinese oil production to increase by 100,000 barrels a day this year to 4.3 million barrels a day. A recent rally in oil prices could also give U.S. shale-oil producers a fresh lease on life.

“It would thus be premature to suggest that OPEC has won the battle for market share. The battle, rather, has just started,” the IEA said.

The Saudis have the funds to make up for the budget shortfalls cheap oil is foisting upon them, but the rest of OPEC isn’t anywhere near as well prepared. Nigeria, Iran, and Venezuela have all agitated for the cartel to take action, though none have volunteered to be the one to actually make the necessary cuts. Saudi Arabia is realistically the only member capable of meaningfully moving the market, but it no longer seems willing to take one for the team, as it were, and cut production. As the IEA pointed out, this price war is only just beginning.

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  • Andrew Allison

    This is a recording: the Saudis have made it perfectly clear they will only cut production in concert with the other members of OPEC. Simply put, they intend to maintain their market share of OPEC production. It’s no secret that the US producers can make money at current prices, that US production is increasing not decreasing, and if the market price increases it will increase even faster. It may well be that recognition that the US has become the swing producer is reason that the Saudis are intent upon maintaining OPEC market share.

    • Dan Greene

      It would be nice if, for once, TAI actually explained the evidence that supports their contention about Saudi motivations.

      • JR

        WE have this wonderful invention called Google. You can actually do some work yourself to see what information exists beyond the hallowed halls of TAI. Website is http://www.google.com It’s great. I actually used that website to come up with an article where Saudi Oil Minister says that they won’t cut production by themselves. He also assured all that there is absolutely no political motivation behind their refusal to cut production. I’m sure leaders of Iran really appreciate the fact that this is completely a-political.

        http://www.middleeasteye.net/news/opec-wont-bear-burden-propping-oil-price-saudi-minister-1604241968

        • Dan Greene

          Not my responsibility to Google on behalf of TAI.

          • JR

            Of course not. Not their responsibility to spoon feed you a link to every statement they make. Yet you act as if it is.
            Hopefully me doing the Googling helped you to see how TAI’s assertion is based on what the Saudi Oil Minister is saying.
            Please note that I’m in no way implying Saudi Oil Minister knows more about Saudi oil industry than Dan Greene. Do I have any evidence that he does? No, sir, no siree bob.

          • Dan Greene

            It’s TAI’s responsibility to provide support for the arguments it makes–a responsibility it regularly fails to meet.

          • JR

            But when they do provide a link, you can claim that it is from an unreliable source which as a matter of fact is what you do. So you can never ever be proven wrong. SWEET!!!

          • Dan Greene

            You are the one who suggested that the TAI piece entitled “Is Iran Cheating Outright” was wrong based solely on the source. I actually made the substantive argument that the piece was wrong. Cite an example of my attacking a TAI piece solely on the basis of the source.

            http://www.the-american-interest.com/2015/05/15/is-iran-cheating-outright/

          • JR

            Oh, I was trolling you. Sorry. Or rather sorrynotsorry since it worked.

          • Dan Greene

            So can you cite a specific example to support your contention or not?

          • JR

            Sigh… Do you really not remember your original post re: Hizbollah? Fine, fine, fine…. This is what you wrote…

            2. With regard to this scrap of Israeli military “intelligence.” We don’t know WHAT it represents. Israel has every incentive to create false accusations against its adversaries. No one has substantiated the claim in this article, so there is absolutely no reason to accept it at face value any more than we should accept the ludicrous claims submitted by Israel to the IAEA purporting to provide evidence of an Iranian nuclear weapons program. It’s always the same dishonesty from the Israelis.

          • Dan Greene

            And your problem with that argument is what?

          • JR

            You asked for a specific example of you dismissing a story based on the source. You got it. That was an example of you doing what you said you never do.

          • Dan Greene

            I did not dismiss it because of its source. I dismissed it because it was nothing but an assertion unaccompanied by any substance–the imagery itself, details of its interpretation, anything at all. That’s what would be required to validate it as “intelligence” rather than just the claim that it is intelligence.

          • JR

            Oh ok… If you think something is not valid, it is not valid. That way, only things that you think are valid are valid. But what process of validation would meet your high standards?

          • Dan Greene

            Why do YOU think that it is valid–since it provided noting verifiable?

          • JR

            I didn’t say it is valid. All I said is that I don’t care about any potential civilian casualties that may result IF Hezbollah does have military installations in civilian centers. If they don’t, than there is nothing for anyone to worry about.

          • Dan Greene

            So we are in agreement that nothing has been provided to demonstrate the validity of the Israeli “intelligence.” Wow–you could have just conceded that hours ago.

          • JR

            No, we agreed that there is nothing that can possible be provided by anyone that you won’t dismiss as Israeli propaganda if it doesn’t fit your world view. I wasn’t sure that I ever not agreed with that.

          • Dan Greene

            Well, we haven’t tested that hypothesis by having you actually provide anything except the Israeli “intelligence” that you concede is unverified. So try something else and we’ll see.

          • JR

            Well, I guess I may have to go the rest of my life with knowledge that I couldn’t convince you. The burden will be heavy, but I hope and pray that I will be able to carry it with dignity.

          • Dan Greene

            You provided nothing, so how could we judge it to be convincing or not convincing?

          • JR

            You provided nothing regarding your Jewish Lobby rants, but that hasn’t stopped you a bit.

          • Dan Greene

            If one country is able to make government ministers of anti-Goyists who obviously despise 98.5% of the population of the state that is subsidizing them, then it’s pretty clear that they must have a pretty powerful lobby and PR machine. Do you deny the pernicious power of the Israel Lobby?

          • JR

            Counterfactual argument again. You are good at those. I think Israel and US have a mutually beneficial alliance. And no, I don’t care that you don’t think so.

          • Dan Greene

            It’s clear that it’s beneficial to Israel. Why is it beneficial to the US?

          • JR

            Why is it important to have alliances with people you share similar values with, especially in an unstable part of the world? Why don’t you read up on the topic and tell me what you have learned.

          • Dan Greene

            “people you share similar values”

            People who share similar values don’t elect a government with leaders who say “A JEW ALWAYS HAS A MUCH HIGHER SOUL THAN A GENTILE, EVEN IF HE IS A HOMOSEXUAL.”

          • JR

            Yes!!! i was going for that cut and paste. Find a new one. Being predictable is not one of your best qualities. Where are those original rants!!! Come on!!! You have one more in you!!!!

          • Dan Greene

            And how does the government who employs such a man “share our values?”

    • Kevin

      They have more than one motive – Undrmine Iran’s ability to finance its war machine, undercut U.S. shale and discourage production and investment in shale R&D, undercut the profitability if alternative energy (bio, solar, wind, etc) to make investment therein look unattractive and unnecessary economically and the goal,if replacing oil look to expensive to pursue, maximizing their own net revenues given the likely reaction of other producers.

      On the other side of the hand, what would they gain from cutting production? Nigeria, Iran and Venezuela’s gratitude? How much is that worth?

      When there are so many motives all pointing in in direction, an analysis should not focus on just one but rather how they all work in tandem to produce the observed behaviot.

  • Josephbleau

    The US government declares monopolies to be illegal, yet price fixing and restriction of trade is allowed in the oil industry. Why is this not an important issue at the UN?

    • Kevin

      Pricie fixing by sovereigns in international markets is not against international law. Even if it were, what’s the remedy? Invasion? If they engage in it in the domestic US (or EU) then it can be pursued – witness Gasprom’s issue before the EU. Or DeBeer’s occassional problems in the U.S.

  • rheddles

    Oh for the good old days of the Texas Railroad Commission.

  • frisco kid

    As an oil industry veteran I believe the Saudis are making a mistake. They can maintain market share only by keeping prices low. Shale oil is not going away until oil drops below $20/barrel ($3/barrel in 1970 dollars). Do the Saudis really want to sell at that price?

  • http://whenfallsthecoliseum.com/author/kwatson/ megapotamus

    Whatever else it has done, the emergence of fracking and other unconventional techniques has put a ceiling on oil prices. Looks like that is going to be about $65. And don’t forget, the technologies do not only make previously unrecoverable deposits viable, some can be applied to existing fields wildly increasing their lifespans. There is no economic reason US gas prices shouldn’t be flirting with sub-dollar lows. There are plenty of political ones but hey! What’s that, really? Forward.

  • http://www.librarything.com/profile/Bretzky1 Brett Champion

    That’s the advantage of having many producers instead of one giant producer. If Saudi Aramco is unprofitable, then the Saudi oil industry is unprofitable. If dozens of oil producers in the US are unprofitable, then they’ll simply be outcompeted and bought up by the profitable firms that have figured out how to be productive. Absent governmental interference, the best producers will always rise to the top.

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