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Petrostates in Peril
OPEC’s Own Outlook Getting Grimmer

Every five years OPEC releases a long-term outlook, and a lot has changed since the last report in 2010. American shale has come on to the scene in a big way, contributing to a global oversupply that, coupled with weak demand, has helped depress prices more than 40 percent in barely a year. OPEC hasn’t acted to constrict production and set a floor to this price slide, consigning its petrostate members to market conditions that push regimes into the red. As Reuters reports, OPEC’s next long-term report suggests prices won’t be rebounding anytime soon:

A draft report of OPEC’s long-term strategy, seen by Reuters ahead of the cartel’s policy meeting in Vienna next week, forecast crude supply from rival non-OPEC producers would grow at least until 2017.

Sluggish global demand for oil means the call on OPEC’s crude will fall from 30 million barrels per day (bpd) in 2014 to 28.2 million in 2017, effectively leaving the group with two options – cut output from current levels of 31 million bpd or be prepared to tolerate depressed oil prices for much longer.

Saudi Arabia has pushed OPEC into its current strategy of competing with non-OPEC producers for market share in the hope that U.S. shale producers might assume the role of the market’s swing producer. While in the past OPEC had to cut production to buoy prices, the Saudis are hoping the high cost of fracking will force American producers to necessarily draw down operations when they can no longer stay profitable, allowing OPEC to produce at will without prices plunging as a result of oversupply.

But it’s not clear that the Saudis and OPEC can have their cake and eat it, too. The breakeven price of oil for most of the cartel’s regimes require is higher than the price most American shale operators need to turn a profit, meaning that even if U.S. shale takes the swing producer mantle, OPEC members will still be saddled with a global price too low to stay solvent. Moreover, shale firms are cutting their own costs through innovative new techniques, like drilling multiple horizontal wells per rig, allowing them to keep producing even in today’s bear market.

OPEC’s new draft report suggests the cartel is keenly aware of the growing threat they face from the rest of the world’s suppliers, and it should give members plenty to discuss at next week’s semiannual meetings.

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  • Kevin

    Comparing a regime’s minimum price to not post a budget deficit and an oil company’s cost per barrel is conflating apples and oranges.

    The budget balancing price is not the cost of production – these countries can mostly profitably produce oil at much lower prices and their production need not drop as the rice does. On the other hand once the price drops under a firm’s cost it will reduce production as it discontinues I profitable operations (though there could e some lag here due to sunk costs etc.).

    Further saying the Saudis succeeded or failed in their price war depends on comparing them not to their budgeting balancing price or what happened a year ago, but rather what there options were. What would have happened if they cut production and tried to coordinate thus with other oroducers? If this production cut would have netted them more revenue (regardless of the budget balancing price) then the decision to maintain production and accept falling prices was economically foolish, if not it was economically wise.

    Fundamentally they (and all other petro-states) have to fit their budget to match net revenues from oil, not the other way around.

    • MartyH

      If the average price for oil over the next five years is $65, then Saudi Arabia has to cut its social spending by a third or so. Imagine the turmoil if the US-a diverse, prosperous, and stable country-tried to do this. There’d be riots in the street. We can’t cut SS for distant future retirees without current retirees freaking out. The social unrest that this will cause Saudi Arabia is going to stress the country a lot-and Saudi Arabia is best positioned of the petrostates. A shooting war may be a consequence-because flailing dictatorships blame outsiders for their troubles, there is already plenty of bad blood between Iran and Saudi Arabia.

      I really think that shale will put a cap on the price of oil at maybe $75. As oil goes above that price, US producers will come online fairly quickly, stopping any rise in its tracks. Ironically, the only hope for OPEC may be to get the price as low as possible to spur demand and get a higher baseline consumption going. Maybe fracking could not meet the added demand, and prices could eventually rise. We’d also have a pretty good worldwide economy at that point.

      Seen a certain way, this is another “Blue Model Failure.” Redistributionist policies fail when revenue is less than expenses, and the recipients of this redistribution are not happy when their proceeds are reduced.

    • Andrew Allison

      Conflating production prices with those necessary for a country to balance is budget is not the only area in which TAI is confused. As I have written before, there is no evidence that the Saudi’s are targeting US shale oil producers. As they have stated, they are willing to cut production in tandem with the other members of OPEC. This is primarily about maintaining Saudi Arabia’s share of OPEC production,

  • ljgude

    Interesting critique of some of this article’s assumptions below. I want to pick up on smaller point made in the article – the capacity of the US shale industry’s ability to remain viable through technological innovation. I don’t know the engineering details but I’ve met people who work in Alaska’s North West Slope and learned that the technological progress involved in horizontal drilling has been far greater than I, or i think the general public, realize. It has been exponential, not linear as we would suppose. The industry’s image is a dirty one and it gets no praise for its innovations from a press just waiting for the next spill. We know that Venezuela has run it’s oil infrastructure into the ground but it is not clear to me how much farther the US oil industry is ahead of the OPEC countries technologically. I think US technological skill has already played a significant role as it has gotten well ahead of other countries with fracking and may surprise us by staying in the game.

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