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Crude Economics
Shale Versus the World

That chart above tells you all you need to know about why OPEC and eleven other petrostates elected to collectively restrain their production last November. That strategy helped push oil prices up between $5 and $10 per barrel, but it hasn’t yet erased the global glut of crude, which means most oil suppliers are still struggling to stay in the black.

A breakeven oil price is the price a given supplier require to turn a profit or, if said supplier is a petrostate like Saudi Arabia or Russia, the price needed to balance the national budget. Even after the slight price rebound over the past four months, Riyadh and Moscow are still far away from erasing their oil-related budget deficits, while the picture looks downright hopeless for Caracas (though that’s not a new feeling for Venezuela these days).

But perhaps even more interesting than these petrostate woes are those two breakeven prices near the bottom of the chart. The lowest, at just $35 per barrel, is a rough estimate of the breakeven price needed for U.S. shale wells currently in operation. There’s little concern in today’s market environment that shale firms might not be able to profitably drill. Shale wells deplete much more quickly than conventional oil projects, so the more relevant metric is the breakeven price for new shale wells, which is somewhere in the region of $50 per barrel. Even with new wells, the outlook for the American shale industry looks strong, given today’s prices.

We should note that shale projects can vary considerably between and even within formations, and that these two U.S. breakeven prices—for new and existing shale wells—are only approximations. That said, the gap between America’s breakeven levels and those of the collected petrostates tells the story of today’s fight for a share of the oil market. Countries like Saudi Arabia and Russia can’t afford to continue on with prices at their current level, but their only lever to alter the price is to constrain their own supply. As we’ve seen already, that plays right into the hands of American producers, who have been eagerly waiting to ramp up their own production should suppliers elsewhere falter.

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  • ljgude

    Only the persistent will discover that you have to hover over the right end of the graph before the two red breakeven point lines appear. Then things make sense. Or maybe my Crome browser has an infirmity. Still the article makes it clear how the petrostates have lost the initiative when it comes to putting the squeeze on the US. I sat in those gas lines back in the early 70s and am not at all unhappy to see the Saudis and the Russkies suffer. I know that isn’t nice, but there you are.

    • D4x

      Thx for the tip. The chart’s true confusion is the label “breakeven price”, which requires this definition: “A breakeven oil price is the price a given supplier require to turn a profit or, if said supplier is a petrostate like Saudi Arabia or Russia, the price needed to balance the national budget. ”

      As if national budgets are as difficult to change as the breakeven price of production. The chart-maker could have labeled Saudi Arabia and Russia lines “breakeven national budget”.

      USA will be exporting more oil to China. That is one difference between 1970’s-OPEC and 2017.

    • Isaiah601

      Winning DOES feel better than losing.

    • Proud Skeptic

      I sat in gas lines, too. I revel in what is happening here.

  • Kevin

    The price a country (or business) needs to balance its books is very different from the marginal price a firm (or a national oil company) needs to break even on its next unit of production. Countries (or businesses) can always cut overhead to break even in the first case. Of course these cuts are painful and countries and firms try to avoid them. However, you if you are below your marginal cost you can’t add or even maintain production for long if the price falls.

    However something doesn’t add up in the common story. If the Saudis average and marginal cost is $10/ barrel, then they could always try to balalance their national budget by ramping up productiion massively and engaging in a price war to drive all the higher cost producers to the wall. (They could just as easily balance their books at 20 m bpd @ $40/barrel as 10m bod @ $70.) That they persist in the current futile strategy implies they can’t bring on substantial amounts of additional production at the same low cost they are reputed to enjoy, or they have an ideological motivation against doing so.

    • f1b0nacc1

      When your economy is almost entirely dependent upon revenues from selling the oil that you pump, marginal cost is essentially meaningless. Yes, the Saudis can make a profit selling oil at $10/barrel, but that means that even with vastly increased market share that would probably be making less overall than if they sold less of it at $40/barrel. Worse yet, their competitors might not be able to match their price, but they are fairly flexible in terms of how much that they can produce, hence the US as a swing producer is a very bad thing for the Saudis. With this in mind, the more that they try to flood the market (and thus drive down the price), the more that they cut their own throats by reducing their national income. Given their extremely high costs (a growing population that is VERY expensive to keep on the dole, and is essentially unproductive in any meaningful sense) in running their state, something has got to give.

      So even if the Saudis could pump enough oil to drive their competitors out of the market (an extremely dubious assumption), they couldn’t sustain it, and as their production inevitably falls, the competitors would come back into the market. This process is not without cost for the Saudis, as it undermines their governments finances and stability over time, and their competitors will be able to adjust their production to accommodate this tactic once it becomes obvious what is going on. Worse still for the Saudis, as technologies advance, more oil is becoming economically recoverable, which lessens their leverage. This means that not only does the “pump till they drop” tactic only have a very short window to work in, it has an ever decreasing horizon in which it can be employed at all.

      Couldn’t happen to a nicer bunch of guys.

    • Proud Skeptic

      One good way to think about it is to imagine a company with a 1000 percent overhead. Sure, you can pump oil and sell it at “x” and make a profit based on your actual costs. But when you factor in that in a petro-state the entire country is the overhead, it changes things dramatically.

  • Jacksonian_Libertarian

    Remember when corner gas stations used to get into price wars? Deja vu! Muwahahaha!

  • DennisP

    Its very interesting to consider the long term implications of US shale oil and production on the global nation-state power balance. What happens to Saudi Arabia and Russia when their national incomes keep going down decade after decade. I’ve been to Saudi Arabia many times and have yet to see anything they have contributed to the world economy except cheap oil – until it wasn’t cheap anymore. Similar things could be said about Russia. The Saudi’s seem to have a real aversion to work – of any kind. It’s looking like the US is back in the drivers seat with oil and gas like we were before 1972. The US shale revolution doesn’t seem to be translating very well anywhere else in the world either. It’s all very interesting.

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