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OPEC's iron grip on oil slides as US shale charges forward

The views and opinions expressed in this blog are those of the author’s and do not necessarily reflect the official policy or position of Hydrocarbon Processing.

At OPEC's recent meeting in Vienna, the Saudi-led oil cartel opted to extend its crude oil production cut by nine months to March 2018. Early approval by Iran—OPEC's second-largest producer—added weight to the decision.

OPEC's November 2016 move to cut 1.8 MMbbl of production has helped support crude prices above $50/bbl so far this year, following three years of crude price drops and revenue declines. The November consensus was adopted by Russia and 10 other non-member countries that typically follow OPEC oil protocol.

The extended production cut is also expected to help OPEC reach its targeted decrease in oil stocks from a record high of 3 Bbbl to its five-year average of 2.7 Bbbl. However, it is likely that cartel members such as Iran and Iraq, which have suffered production losses in the past as a result of political conflict and sanctions, will push for higher output in the future.

The increase in the price of oil above $50/bbl has created an undesirable scenario for OPEC—rising output of shale oil in the US. The US ranks alongside Russia and Saudi Arabia as one of the world's largest oil producers. OPEC is keen to avoid pushing crude prices too high, as this would provide incentive for US shale producers to ramp up output further.

US shale stands its ground. Shale producers' ability to largely maintain output during the past few years of low oil prices indicates that OPEC's hold on international oil prices is loosening, and quickly.

The cartel's strategic decision to increase, decrease or maintain its output has traditionally had a significant impact on international oil prices. However, in mid-May, OPEC issued a surprise request in its monthly oil report, asking the US to stop producing so much oil.

OPEC wrote that achieving a global oil market balance would "…require the collective efforts of all oil producers," and would be "…not only for the benefit of the individual countries, but also for the general prosperity of the world economy."

Walking the market tightrope. To some, the cartel's call for assistance carried a touch of irony. OPEC began bumping up its crude output from 2014 in an attempt to squeeze US shale producers out of the market. US rig counts dropped in 2015 and 2016 as oil prices plummeted below $30/bbl, putting a 900-Mbpd dent in domestic shale oil output.

However, the cartel's strategy failed to impose a lasting handicap on US producers—which are not regulated by the government, unlike the massive state oil companies of OPEC nations. A new IHS Markit forecast calls for an increase in annual average crude output in the US and Canada of 1.6 MMbpd between 2016 and 2018.

The US alone is expected to pump 900 Mbpd more oil in 2017 than it did last year, making up the difference in production losses seen in 2015 and 2016. Furthermore, financial institutions are now projecting increases in US shale production in 2018 of 950 Mbpd to 1.05 MMbpd.

OPEC examines options amid sliding control. OPEC's move to paralyze the US oil market forced the governments of Saudi Arabia, Russia and other countries to implement austerity measures in 2015 and 2016 as prices dove, effectively creating a self-imposed handicap on the cartel. It also led to unrest in the oil-producing countries of Venezuela and Nigeria. During this time, some US shale producers stumbled and others persevered, in an anticipated market balancing act.

Underlining the cartel's growing struggle, the Saudi government in April 2016 issued a plan to raise its non-oil revenues sixfold by 2030, to $266 B, and to list a portion of national oil company Aramco on the stock exchange.

The government cited a "dangerous state of addiction to oil" that has "held up many sectors from developing in the past years" for its decision to de-emphasize oil revenues. At present, oil accounts for approximately 87% of the Kingdom's annual income.

A new swing producer for global oil. The US' continued pumping of shale oil over the past few years has disrupted OPEC's efforts to precisely manipulate oil prices. The resilience of US shale has led some analysts to reclassify the US as the new primary "swing producer" in the oil market.

Of particular benefit to US shale producers is the increasing variety of capital sources available to finance well drilling. These sources include bank and private loans, advance oil sales, and high-yield bonds, among others.

Shale production becomes lucrative at around $52/bbl, and activity increases rapidly above that price. In some areas of the Eagle Ford shale, production is reported to be profitable at a crude price of as low as $34/bbl—a level last seen in 2016.

A sure pattern is emerging: The higher oil prices rise, the faster US shale drilling will increase, and the deeper OPEC's cuts will need to be to protect its profitability. The cartel will need to walk an unsteady tightrope, and carefully, if it wants to maintain its clout in the market.

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