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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