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Page added on November 3, 2016
OPEC Is Now Irrelevant – This Oil Price Plunge Is Different
OPEC Price Band
Not very long ago, oil prices traded at well below $20/b and OPEC anxiously came up with a mechanism which it termed as “OPEC Price Band’ $22-$28/b”. The rationale for this price band, was that OPEC members would find it sufficient for the growth of their oil and gas industry while the price was high enough to meet their government budgetary requirements. However, only a few years after this mechanism was introduced, oil prices exploded upwards and OPEC was forced to abolish its own price band in favour of higher oil prices.
Burgeoning Oil Prices – OPEC Fortune
Oil prices rose higher and higher, and in July 2008 peaked at $147/b – good news for oil producers and oil exporters but painful for the oil importing countries and particularly for consumers.
There are many reasons for the rise in oil prices since 2003 – market fundamentals, civil unrest/strikes in some of the major oil producing countries, the flip/flop of inventories, speculators, hurricanes, conflict in Middle East, and higher cost of production. Shortly after these record prices, the world witnessed the abrupt collapse of oil prices to below $40/b in late 2008 and early 2009.
Surprisingly, oil prices then bounced back and remained over $100/b for quite an extended period of time before plunging back below $30/b.
The key developments in oil prices from 2007 to September 2016 are highlighted in the following bullet points:
• 2007-2008 – Over a 20-month period, oil prices (average monthly Brent) moved up from $53.68/b in January 2007 to 113.02/b in August 2008 (July averaged $133.16, though oil prices went as high as $147/b). Only 6 of these 20 months saw oil prices above $100/b, averaging $88.59/b over the period.
• 2008-2009 – Over a 7-month period (Sept 2008-March 2009), oil prices moved down from $98.13/b in September 2008 to $40.35/b in December 2008, averaging $56.58/b.
• 2009-2014 – Over a 64-month period (April 2009-July 2014), oil prices remained above $100/b for 42 months, averaging 97.89/b.
• 2014-2016 – Over this 26-months period (Aug 2014-Sept 2016), oil prices moved down from $106.64/b in July 2014 to $46.69/b in September 2016 (with a low of $30.75 in January 2014), so far averaging $54.33/b. However, since August 2015, average monthly oil prices have remained below $50/b.
OPEC’s Successful Policies
In the past, whenever oil prices have slumped OPEC would help them to recover promptly through the sincere and concerted efforts of OPEC members. So, what is different this time? Oil prices have remained well below $50/b or hovering close to $50/b over extended period of time. Why are OPEC members not happy with the oil price tag of $50/b as compared to the old OPEC price band of $22-$28/b? Will OPEC be able to steer oil prices to its desired levels, enabling its members to meet their respective government’s budgetary requirements (ranging from $47 in Kuwait to over $215/b Libya)? If not, then what should be done to keep their economies afloat without heavy reliance on the oil and gas sector?
A Dilemma for OPEC Policies
When oil prices tumbled down after mid 2014, OPEC discovered that the main culprit was the booming U.S. shale oil industry. The cartel had to decide how to deal with this new emerging threat. The decision was between living together in a competitive market or attempting cut the emerging shale industry at the knees by means of sustained low prices.
OPEC decided to take the later approach. Instead of taking cost cutting measures to meet the new challenges from U.S. shale oil and diversifying their oil based economies, they flooded the market. A clear intent was to keep oil prices low and knock out U.S. shale oil producers in order to maintain market share. The perception was that in just a few months, the U.S. shale oil industry would have perished, unable to cope with the lower oil price environment over an extended period of time.
OPEC Policies Back Fire
Contrary to their expectations, U.S. shale oil production did not decline as much as anticipated. In fact, OPEC – hurt by their own action of flooding the market – kept the oil prices lower for longer still. The cartel was seemingly unaware of the speed of technological advancement that continues to bring down breakeven prices for shale. Advances in drilling technology, optimized resource management policies and the smart use of hedging have allowed the U.S. shale oil industry as a whole to stay afloat even as bankruptcies pile up.
The consequences of a prolonged period of softer oil prices has now started to pinch OPEC nations themselves. The plan to defeat shale oil producers backfired. Middle-East stock exchanges, fiscal policies and economic growth became the immediate casualty of this strategy. Efforts were made to reduce fiscal deficits by improving non-oil revenues and other austerity measures including cutting subsidies, but are these measures enough?
What is Different This Time?
With no alternative choice, OPEC went back to its old wisdom of manipulating oil production as it has done so successful in the past. Knowing that this time around, this monster task cannot be accomplished without the support of Russia, so efforts were made to motivate Russia to board the sinking ship. Russia needed to join due to its economy reeling from low oil prices. In the past few months, the news of such freeze/production cuts has had an impact on market sentiments the same way as it had in the past. That is, any news of a production cut or freeze pushed and prodded oil prices upwards. Repeatedly, OPEC’s members failed to agree on a tangible production cut, asking to be exempted for their own political and economic reasons.
Mediocre cash flows have pushed oil producers to up output even further. Both Russian and Saudi Arabian production was up over 11 mmbd, despite weaker global oil demand. Consequently, oil prices remained subdued as the supply glut continued unabated. Oilprice.com’s Andreas de Vries and Salman Ghouri recently published an article on the 5-negative factors for oil prices that highlights why oil continues to sell off.
Challenges for the oil industry in the short/long term
U.S. shale oil remains the biggest threat to the industry and oil prices over the short-medium term. While structural changes in the automotive industry and the rising role of renewables are yet another threat that challenges the survival of oil in the medium to long-term.
U.S. shale is not only reducing break-even cost, but they also learned how to respond to changes in oil prices. A good example of this is the reduction in well completion. DUCs were piling up as oil prices remained under $50. At the end of September 2016, the number of DUCs were up to 5069 from 3698 in December 2013. In contrast, the number of DUCs declined when oil prices went above $50 as the chart below shows.
(Click to enlarge)
Figure-1: US shale oil drilling profile
How Responsive Is U.S. Shale Oil to Oil Prices
As far as future of U.S. shale oil is concerned, if oil prices are allowed to increase from $50/b to $80/b due to OPEC and Russia’s successful collaboration, the question is how long it takes shale oil to respond?
The Author published a paper “Will OPEC Use This Strategy To Defeat U.S. Shale?” which highlights that if oil prices are allowed to increase from $50/b to $78/b between March 2016 to December 2020 how U.S. shale production would respond to price changes. In the reference case, U.S. shale oil production from the Bakken, Eagle Ford, Niobrara, Permian and Utica responded due to the increase in oil prices, surpassing their respective peaks to date. By December 2020, total U.S. shale oil production from the given seven basins is forecasted to increase to 6.78 mmbd – an increase of 48 percent compared to 4.86 mmbd in September 2016.
(Click to enlarge)
Figure-2: US Shale oil forecast March 2016 to Dec 2020.
What Can The Oil Industry Do To Improve Their Odds?
The oil industry should realize sooner or later that the era of $100/b or over is technically over. The underlying threats are real and they should develop alternate strategies for their own survival. Moreover, oil dependent countries should also look for other options to reduce their reliance on oil based revenues, removing subsidies and introduce tax reforms are just two options to avert a major economic downturn.
By Salman Ghouri for Oilprice.com
22 Comments on "OPEC Is Now Irrelevant – This Oil Price Plunge Is Different"
rockman on Thu, 3rd Nov 2016 9:08 pm
I wish I had the energy to point out every piece of complete bullshit in this article. But I don’t. Take over. LOL.
Truth Has A Liberal Bias on Thu, 3rd Nov 2016 9:47 pm
Holy fuck was that ever dumb. I wonder if he gets paid for that shit? OPEC is not exactly a homogenous organization, I wonder if this dick knuckle thinks Venezuela and Nigeria is part of the big OPEC conspiracy to keep prices low.
penury on Fri, 4th Nov 2016 11:52 am
Another U.S. centric article. How do I know? Easy the authors refuse to admit that the major part of the conundrum is that people can no loner afford all the goodies which used to be made using oil, people can no longer afford the shipping or storage of the4se items. The economy of the world is contracting we no longer are able to expand, party is over.
Plantagenet on Fri, 4th Nov 2016 12:31 pm
penury is right—the article is too “US-centric.” For instance, it ignores the impact that increasing Iranian and Iraqi oil production and exports have had on the oil glut, instead attributing it all to increasing US shale oil production.
Cheers!
Kenz300 on Fri, 4th Nov 2016 12:56 pm
The oil companies and the auto companies need to get their collective heads out of the sand and realize that the world is changing with or without them.
Climate Change is real….. it will impact all of us…
It is time to move away from fossil fuels and embrace alternative energy sources like wind, solar, wave energy, geothermal and second generation biofuels made from algae, cellulose and waste. They need to change their business models and move from being OIL companies to ENERGY companies. The auto industry needs to move from just building compliance vehicles to embracing electric vehicles and start putting development and advertising behind them..
Boat on Fri, 4th Nov 2016 1:21 pm
“U.S. shale is not only reducing break-even cost, but they also learned how to respond to changes in oil prices. A good example of this is the reduction in well completion. DUCs were piling up as oil prices remained under $50. At the end of September 2016, the number of DUCs were up to 5069 from 3698 in December 2013. In contrast, the number of DUCs declined when oil prices went above $50 as the chart below shows.”
I don’t think having a bunch of DUCT’s sitting around would be considered a good response to prices. Millions of dollars were spent on each well.
Boat on Fri, 4th Nov 2016 3:00 pm
Prepare for North Sea oil flood as OPEC plans output curbs
Shipments of North Sea grades will increase 10 percent month-on-month to about 2.16 million barrels a day in December, according to data compiled by Bloomberg. If all the cargoes load as planned it would mark the most crude oil shipments from the region since May 2012. The increase just from September, when there was field maintenance, would be almost 360,000 barrels a day.
https://www.pressandjournal.co.uk/fp/business/1075246/prepare-north-sea-oil-flood-opec-plans-output-curbs/
onlooker on Fri, 4th Nov 2016 4:32 pm
So long as oil is used as a source of energy, when
the energy cost of recovering a barrel of oil becomes
greater than the energy content of the oil, production
will cease no matter what the monetary price may
be.” (M. King Hubbert)
mx on Fri, 4th Nov 2016 4:47 pm
If Russia says they can produce at $10 a barrel, it’s over.
And that’s believable with Russian currency devaluation.
mx on Fri, 4th Nov 2016 4:48 pm
Russia will become the #1 producer.
Everyone else will have to cut production to raise prices, or go bankrupt.
joe on Sat, 5th Nov 2016 1:26 am
Problem: Too much product. Effect:Price drop cause by over supply and certainty of supply. Solution1: Reduce Supply (budget constraints limit this option. Solution2: Decrease certainty of supply (very hard for OPEC to upset supply of US/Canadian tight oil). New effect, OPEC countries are in deep trouble because of changes caused by Peak Easy Oil. They can either change their lazy attitudes and reduce their massive government sectors and get work and stop looking to ways to wage jihad or they can suffer the consequences of doing nothing and remaining one trick ponies.
makati1 on Sat, 5th Nov 2016 1:41 am
U$/Canadian tight oil? How long will that flow as the price drops? Not long, I suspect.
joe on Sat, 5th Nov 2016 2:14 am
Mak, I think that cash is king, and when money is cheap, cash can be found to pay for supply costs. When interest rates go back up, tight oil will be in a much more unhealthy environment for itself. Why does the stock market fall every time someone mentions rate hikes? More expensive money will be like putting salt on a snail for the entire US market. Theyll do it though because the money masters are not getting rich fast enough. People forget that money is just a medium of the exchange of human labour, so moeny is our way of making our work physically real, oil is potential work so its true value to us is what we can exchange of our labour to get it. The more we are forced by money changers to pay for oil (interest rates) the less likely we are to use tight oil (so its value/utility falls) through the mechanism of higher prices (reduced supply). The good news is that waiting in the wings now are people like Tesla who actually can help keep society moving albeit in a different way, but society and culture changes over the long term and we need to embrace that, not fight it. Trumps America of the 50s is now coming back, nor will Hillaries starry eyed optimism of her youth before she foolishly ran off after Bill and proved to us just what a bad judge of people she actually is. We all chase dreams.
joe on Sat, 5th Nov 2016 2:15 am
Meant not coming back btw
makati1 on Sat, 5th Nov 2016 2:54 am
Tesla! Your rebuttal has some validity until you mentioned that shyster. LMAO.
The oil industry will fail along with everything else when the SHTF. You can parrot all the bullshit flowing out of every desperate source trying to keep BAU alive when it is really in the ICU and Reality is about to pull it’s plug, but that changed nothing. I just hope you do not have kids or grand kids who expect a long, happy, healthy life. It ain’t going to happen.
What makes oil so god-like in your mind? It isn’t. The world managed for all of its billions of years without burning oil and it will manage for billions more. We humans will be gone soon and then it can go back to normal.
joe on Sat, 5th Nov 2016 4:26 am
Mak its not a rebuttal. Im saying the world is changing, but I would prefer a world with a down slope as shallow as possible, rather than the cliff dive we seem bent on heading for is my prefered option. Humans sadly are fundamentally racist and bigoted and greedy, we share and cooperate only when it serves our interests. Right now governments have no grasp of their interests because they live in the modern world, not tomorrows. We need to make a choice similar to the one that Churchill made when he switched the Royal Navy to oil burning, that choice will be as hard to reverse as it was easy to make. To tell the world they are screwed economically if they try to save the earth goes against our evolutionary path. By the time we do decide, it will be too late.
makati1 on Sat, 5th Nov 2016 4:44 am
joe, but we will never make the choice that might save us. Not even as we go over the cliff. It’s not in our genes. Buckle up. A rough ride is ahead.
Kenz300 on Sat, 5th Nov 2016 11:04 am
The oil companies and the auto companies need to get their collective heads out of the sand and realize that the world is changing with or without them.
Climate Change is real….. we will all be impacted by it
Exxon’s Climate Change Cover-Up Is ‘Unparalleled Evil,’ Says Activist
http://www.huffingtonpost.com/entry/exxon-evil-bill-mckibben_561e7362e4b028dd7ea5f45f?utm_hp_ref=green&ir=Green§ion=green
mx on Sat, 5th Nov 2016 11:50 am
Tesla, now has 12 Billion dollars in Assets on it’s balance sheet, with the most advanced battery factory and assembly lines in the world.
If that’s your definition shyster, America Needs More Of Those.
Remember, those are AMERICAN Jobs.
China building gigawatts of solar projects now, and bidding on American Wind Farm Projects.
If you’re an Exxon investor, you’d better start a RIOT at the next meeting, because the world is rapidly moving away from what Exxon sells, now you can ignore that and see Exxon lose 80% of it’s stock price, or you get Join the Real Changing World.
rockman on Sat, 5th Nov 2016 7:34 pm
“…when the energy cost of recovering a barrel of oil becomes greater than the energy content of the oil, production will cease no matter what the monetary price may”.
Not necessarily true. What is true: When
the MONETARY cost of recovering a barrel of oil becomes greater than the MONETARY value of the oil produced, production will cease.
Simply if 1 Btu of oil selling for $10 is produced using 1.3 Btu of energy that cost $8 then the oil will be produced. There two primary energy sources used to produce the oil sands: NG and the bitumin itself. A NG Btu cost considerably less the “dilbit” Btu. Don’t take my word for it…google it yourself.
Here’s one view:
“The amount of energy required to produce bitumen has been a hot topic for many years. Some argue that these projects are a poor way to use energy. If you are using cheap energy inputs to produce a higher value product, then a low EROEI might be perfectly acceptable from an economic point of view. In the case of SAGD, they are using cheap natural gas to produce much more valuable crude oil. Thus, in this case a low EROEI itself says nothing about the economic viability of the process.
What a low EROEI does indicate is that fossil fuel resources are being depleted at a faster rate; the lower the EROEI the faster the depletion. Thus, lower EROEI projects are generally worse from an environmental and GHG emissions point of view.”
The tough number to come up with is how much raw bitumin is used in the process. The lack of data may indicate operators are keeping that info proprietary. There is very little to no market for unrefined and unblended production. Again research yourself to understand that nearly all the bitumin pipelined to the US is acutally “dilbit” that contains 25% to 30% light oil. But that’s not a Btu “expense” since every one of the light oil Btu’s are recovered in the refining phase
OTOH it’s only far to included the light oil cost in the total extraction cost. OTOOH a significant portion of the sales price of the dilbit is the light oil component. I’ve been unable to come up with even a rough guess of the Btu extraction volume and COST to compare to the Btu production volume and its VALUE.
But if the Btu costs + all other costs is less then the what those dilbit Btu’s are selling for then the oil sands will be produced. Obvious with the crash of oil that differential has been greatly reduced indecent years. OTOH the cost of the 750,000 bbls of light oil blended DAILY to make dilbit has also declined significantly.
A rather complex economic model especially when much of the data isn’t readily available.
mx on Mon, 7th Nov 2016 9:43 am
Russian oil could be sold at $11 a barrel.
The Canadian Tar Sands are going to be shutdown, as Russia expands production.
mx on Mon, 7th Nov 2016 9:44 am
You’re doing the Koch Bros a favor by shutting it down early and helping them to Not go bankrupt.