It’s been almost six months since OPEC last convened, and at that semi-annual meeting Saudi Arabia managed to convince (or maybe more accurately coerce) the rest of the cartel’s members into going along with its plan of inaction. Though historically OPEC has acted to cut production in times of falling prices, this time around the Saudis seemed intent on competing with non-OPEC producers—chief among them U.S. shale firms—for market share. At that time, the price of oil had fallen more than $30 per barrel from a $115 peak in June, and since then we’ve seen crude fall another $35 per barrel to a low of around $45 in January before rebounding to roughly $65 per barrel today. For a market that has consistently traded above $100 per barrel for three and a half years, this has been a roller coaster ride.
Next week, OPEC will once again come together to plan their next move, and all signs are pointing towards more of the same; namely, drill, baby, drill. As Bloomberg reports, some think the Saudis can already tout their strategy as a success:
“The Saudis probably feel their strategy is working, and rightly so,” Francisco Blanch, Bank of America’s head of commodities research, said by phone from New York. “There’s a major decline in the U.S. rig count, and a huge reduction in capex spending. That’s a sign the strategy is working.” […]
“The fact that prices have recovered somewhat, and we appear to be past the bottom, that’s something the Saudis will be able to point to in their discussions,” Mike Wittner, head of oil market research at Societe Generale, said by phone from New York on May 19. “And the other thing they’ll be able to point to is that U.S. production has topped out.”
That’s certainly one way to read the market. Here’s another: the price of oil seems to have stabilized of late at around $65 per barrel, a level far below the Saudi breakeven price (the cost per barrel of oil that the Saudis need to balance their budget) of $103, Libya’s (a staggering $215), Algeria’s ($111.10), Iran’s ($92.50), Venezuela’s ($89), Nigeria’s ($87.90), Russia’s ($78), the UAE’s ($73.10), and Iraq’s ($70.90). All of those OPEC members are running in the red at today’s prices.
Saudi Arabia has prepared for this day and has a massive sovereign wealth fund that it can withdraw from to make ends meet, as do many of its other fellow petrostates, but those are stop-gap measures. Over the long-term the majority of OPEC needs one of two things: the global price of oil to rise, or government budgets to shrink.
With Iraq prepared to export a record amount of crude next month and Iran readying its own output renaissance if and when Western sanctions are lifted as a result of the nuclear deal, it seems likely that the market will remain oversupplied—and prices therefore will remain low—for the time being. That leaves budget cuts, a move many petrostate regimes are loathe to carry out for fear of the civil unrest it may inspire.
Meanwhile, the target of the Saudi strategy—American shale—is faring better than expected. True, we’ve seen a dramatic drop in the number of active rigs, but this isn’t a perfect metric by which to judge the industry. Most troubling for OPEC is the work being done to bring shale breakeven costs down by innovating new ways to cut costs and stay profitable. Remember, the U.S. shale boom is still very young, and it stands to reason that there remain plenty of opportunities to refine extraction methods.
OPEC is divided on its current strategy, and you can be sure there will be some heated discussions at next week’s meetings, but as the cartel’s largest producer, the Saudis hold the reins. If they think their strategy is working, OPEC will continue to keep the crude flowing, but don’t think for a second that the world’s petrostates are enjoying themselves these days.