For the first time in eight years, the Organization of the Petroleum Exporting Countries (OPEC) has agreed to collectively cut production, a delayed and somewhat desperate response to the precipitous drop in oil prices over the past 29 months. The FT reports:
The meeting is continuing as individual country allocations are hammered out, but sources said the main obstacles to the deal had been overcome. It will see the 13-member group reduce output by about 4.5 per cent, or 1.2m a barrels a day, with production targets for each member country. […]
Saudi Arabia is expected to shoulder the bulk of any production cuts along with its Gulf allies. In return, Iran is expected to freeze production at about 3.8m barrels a day, close to its current rate, according to third-party assessments used by Opec.
The cartel hopes that its actions will reduce the glut of crude that set off this price collapse in the first place and induce a market rebound, and we’re already seeing signs of recovery in trading today—Brent crude jumped more than 8 percent to top $50 per barrel, while WTI (the American oil benchmark) rose more than $3.50 to just under $49 per barrel.
But two big questions still need to be answered, the first of which is: Just how far will prices rebound on OPEC’s actions (and Russia’s potential cooperation)? This is critically important to the cartel’s petrostates, all of whom would like to see a return of those heady $100+ per barrel days. Many OPEC members are running fiscal deficits at current prices: Saudi Arabia needs crude to trade above $79 to stay in the black; Iran requires a breakeven price of $55; Algeria, Bahrain, the UAE, and Libya have fiscal breakeven prices of $87, $95, $71, and $195, respectively.
For more than two years, OPEC—led by the Saudis—has decided not to intervene to stop sliding prices, choosing instead to fight for a share of the crowded market. The fact that the cartel is now moving to act shows how important it is for these petrostates to fetch higher prices for their all-important exports, which brings us back to this first question: how much will this cut affect the market?
The answer to that largely depends on the second major unknown in this equation, namely the responsiveness of American shale. How quickly will U.S. frackers be able to adjust to rising prices by ramping up their own production? Analysts expected tight oil output to fall off a cliff when oil prices dropped below $75 per barrel two years ago, but shale producers surprised the world with their ability to cut costs and keep the crude flowing in a bearish market. As Reuters reports, American producers have grown lean and mean in recent years, forged in the crucible of bargain oil prices:
In shale fields from Texas to North Dakota, production costs have roughly halved since 2014, when Saudi Arabia signaled an output free-for-all in an attempt to drive higher-cost shale producers out of the market. Rather than killing the U.S. shale industry, the ensuing two-year price war made shale a stronger rival, even in the current low-price environment. […]
The breakeven cost per barrel, on average, to produce Bakken shale at the wellhead has fallen to $29.44 in 2016 from $59.03 in 2014, according to consultancy Rystad Energy. It added that in terms of wellhead prices, Bakken is the most competitive of major U.S. shale plays. Wood Mackenzie said technology advances should further reduce breakeven points.
And so, while OPEC—and in particular Saudi Arabia—bites the bullet and concedes to these production cuts, producers around the world stand to benefit from a bump in prices. Here in the U.S., this should mean a corresponding rise in output as more plays become profitable. That would work to offset the clamp on global supply OPEC is trying to accomplish, and therefore blunt the effect of this cut while simultaneously helping American producers gain a greater share of the global market.
This is why Riyadh has been so loathe to agree to a cut. The extent to which U.S. shale firms are able to capitalize on rising prices will determine how successful this reluctant change in the petrostates’ tactics will be.