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Page added on December 7, 2014
OPEC shows U.S. oil producers who’s boss
To paraphrase Mark Twain: Rumors of OPEC’s demise have been greatly exaggerated.
Breathless coverage of the rise in U.S. oil production in the last few years has led some to declare that OPEC’s power in the oil market is now becoming irrelevant as America supposedly moves toward energy independence. This coverage, however, has obscured the fact that almost all of that rise in production has come in the form of high-cost tight oil found in deep shale deposits.
The rather silly assumption was that oil prices would continue to hover above $100 per barrel indefinitely, making the exploitation of that tight oil profitable indefinitely. Anyone who understood the economics of this type of production and the dynamics of the oil market knew better. And now, the overhyped narrative of American oil self-sufficiency is about to take a big hit.
After weeks of speculation about the true motives behind OPEC’s decision to maintain production in the face of declining world demand–which has led to a major slump in oil prices–the oil cartel explicitly stated at its most recent meeting that it is trying to destroy U.S. tight oil production by making it unprofitable.
One of the things a cartel can do–if it controls enough market share–is destroy competition through a price war. Somehow the public and policymakers got fixated on OPEC’s ability to restrict production in order to raise prices and forgot about its ability to flood the world market with oil and not just stabilize prices, but cause them to crash.
The industry claims that most U.S. tight oil plays are profitable below $80. And, drillers say they are driving production costs down and can weather lower prices. OPEC’s move will now test these statements. The current American benchmark futures price of about $65 per barrel suggests that OPEC took into consideration the breakeven points cited in the linked article above.
It is largely Saudi Arabia which enables OPEC to have production flexibility since the kingdom maintains significant spare capacity, declared to be in the range of 1.5 to 2 million barrels per day (mbpd). OPEC says in its “World Oil Outlook 2014” that all of OPEC has about 4 mbpd of spare capacity, though one analyst recently put the number at 3.3 mbpd.
Whatever the precise number, in practical terms Saudi Arabia is the Walmart of world oil markets, able to affect a price drop at the turn of a few valves or through failure to turn them off in the face of falling demand. In this case, the country did not turn off any of its production in response to weakening world demand. Nor did other OPEC members. Having twisted enough arms in the most recent OPEC meeting, Saudi Arabia got its way with a commitment from OPEC members to hold production steady, thus putting further pressure on the oil price in the wake of falling demand. Both of the world’s major oil futures contracts fell by 7 percent after the announcement.
The effect has been far greater in North Dakota than the ongoing drop in futures prices would indicate. That state, which is at the center of the U.S. tight oil boom, is far from refineries and pipelines. Oil producers use expensive rail transport to carry their oil to market. The result is that North Dakota producers face a significant discount at the wellhead. For October the average discount was $15.40 per barrel below the U.S. benchmark Light Sweet Crude futures price. If we take that discount and apply it to last Friday’s close, that would imply that North Dakota producers are now receiving $50.59 per barrel–a level unlikely to be profitable except for the most prolific wells.
If prices remain that low, OPEC will almost certainly achieve its objective of preventing significant investment in new production in the state. Other major tight oil production is centered in Texas, closer to pipelines and thus not subject to discounts of this magnitude. Still, with oil around $65 per barrel, it is likely that production would rise very little in Texas in the tight oil plays, if at all. Deposits outside the “sweet spots” currently being drilled are almost certainly uneconomic at such prices.
If a prolonged low price leads to painful and permanent losses for owners of shares and bonds of the tight oil drillers–and for those invested directly in actual wells–there will be less appetite among investors to rush in even when oil prices recover. That’s precisely what OPEC is counting upon. It knows that free cash flow (cash earned from operations minus capital expenditures) for independent drillers has been wildly negative since 2010. The furious drilling of the past few years has been financed largely by share issues and debt rather than earnings from previous wells.
At these new low oil prices, it’s unlikely that many investors will be willing to put more money to work in the tight oil deposits of America. That will make it hard for drillers to fund new drilling since they have insufficient cash being generated by current operations. In addition, with oil prices significantly down, many independent drillers may have a hard time paying off their debts, let alone paying the costs of drilling a large number of new wells. And with yearly field production decline rates in tight oil areas of about 40 percent–which simply means that no drilling for a year would result in a 40 percent decline in production–drillers have to drill a large number of new wells just to make up for production declines in existing wells BEFORE they get to new wells that actually add to the overall rate of production. A significant drop in the rate of drilling in U.S. tight oil plays could actually result in lower overall U.S. oil production.
Lower oil prices tend to increase demand for oil as people can afford more energy for consumer and industrial purposes. So, OPEC is fully expecting demand and then prices to rise over the medium term–but not, it hopes, soon enough to bail out tight oil drillers.
All things being equal, lower oil prices tend to increase economic activity and may help Europe and Asia avoid a recession by lowering energy costs significantly. But all things may not be equal since at least one analyst believes the current rout in the oil markets could lead to cascading defaults that start with the junk bond debt of oil drillers and move through banks heavily invested in oil company debt. That, in turn, could cause a general stock market collapse. Thus, instead of promoting economic growth, low oil prices would be the cause of the next stock market crash and the next worldwide recession.
Such a recession would likely sink oil prices further, putting extreme financial pressure on OPEC members less well-endowed than Saudi Arabia. And, it would upset OPEC’s timetable for a return to higher prices and profits–delaying it perhaps for years. It would also put another nail in the coffin of the American oil independence story–one that even the ever-optimistic U.S. Department of Energy never believed at high prices–by moving many of the U.S. oil plays previously considered viable into the uneconomic category.
Image: “Lithographs showing Brittania sitting alone in a stagecoach named “Free Trade; 1846” on the road to Prosperity, waiting to be joined by the figures representing Germany, France, Austria, USA, Switzerland and Russia which are standing on a hill behind the coach. The accompanying picture shows the foreign nationals sharing a car called “Protection; 1910”, also on the road to Prosperity, leaving the stagecoach far behind. Artist: Unknown Printer: McCorquodale and Co Ltd Publisher: Printer Place of Production: London Date: c1905-c1910. “Source: Wikimedia Commons.”
31 Comments on "OPEC shows U.S. oil producers who’s boss"
paulo1 on Sun, 7th Dec 2014 12:56 pm
This action of lower prices may have a few unintended consequences for everyone, OPEC included.
Excellent article. I suppose the discussion will further focus once a few LTO defaults and bankruptcies occur. Until then, it’s only been a few months and even a sick industry can hide illness for awhile yet. The drop in drilling permits in November is the first sign of an impending day of reckoning, though.
How fast will this gather steam? Plus, coupled with a lacklustre buying cycle this Black Friday through Christmas, the outcry will be loud and shrill.
The problem can only be hidden by either war or some huge geo-political event. Look for further crisis to occupy CNN wags.
Plantagenet on Sun, 7th Dec 2014 1:08 pm
While the low oil prices are going to hurt the US oil sector, the rest of the US economy is likely to benefit. The stock market is showing no signs of an economic slowdown in the US, as stocks continue to go up.
If there were actually signs of a US recession coming, the market would go down.
shortonoil on Sun, 7th Dec 2014 1:15 pm
OPEC is not doing one dam thing that it wasn’t doing 3 years ago. LTO isn’t even competition for OPEC because at least half of it doesn’t produce transportation fuels, half of it is a feed stock material. These writers pushing the Bogey Man theme should be horse whipped. LTO is failing because it never was worth very much, and still isn’t. It is an net energy dead man walking.
Plantagenet on Sun, 7th Dec 2014 3:10 pm
@shortonoil.
You are right that OPEC isn’t doing anything different. But you somehow miss the fact the US is producing millions more barrels of oil each day then it was just a few years ago. The extra oil from US tight oil plays has created an oil glut, causing the price of oil to plummet.
Get it now?
MKohnen on Sun, 7th Dec 2014 3:42 pm
Plant,
Do the math! If the global economy was growing at a lackluster 2%, the “extra oil from US tight oil plays” could never cause a glut. If the US was growing at its supposed 4%, especially with a boom in manufacturing as we are being told, the need for FF’s in the US would skyrocket, and there would be a shortage, not a glut. So, it’s true that OPEC isn’t doing anything different. It’s also true that the supposed “glut” caused by fracking isn’t doing anything, either. It’s the global economic recession that’s doing all the heavy lifting, and it’s guaranteed to continue and get worse. Which means that if OPEC continues to do nothing different, shale oil is in huge trouble.
Davy on Sun, 7th Dec 2014 3:43 pm
Planter, what part of black-piss don’t you get? LTO is not quality nor quantity. It is something for the corns to porn IOW snake oil.
shortonoil on Sun, 7th Dec 2014 4:07 pm
But you somehow miss the fact the US is producing millions more barrels of oil each day then it was just a few years ago.
Between 2003 and 2004 world oil production increased 3.05 mb/d. That is almost as much as shale has increased in seven years, and shale is the only increase in production we have seen recently. Between 2003 and 2004 there was no such thing as an “oil glut”, and prices were going up. The world easily absorbed the added production.
Now the world’s economy is dying from the camel pea they are pedaling off as oil. Half of it is nothing more than a precursor to a piece of plastic pipe. The value of oil is falling because it isn’t able to power its own extraction, to say nothing of the world’s economy.
Get it now?
penury on Sun, 7th Dec 2014 4:28 pm
Low oil prices are a symptom.High rates of unemployment are a symptom. Manufacturers and distributors turning to robots are a symptom. The problem is there is not enough demand for oil. Unless and until demand increases prices will remain low. Prices cannot increase until people have more money, People will not have more money until job growth occurs. Job growth will not occur until people have more money I do believe we have reached a paradox. Enjoy.
marmico on Sun, 7th Dec 2014 5:00 pm
Between 2003 and 2004 world oil production increased 3.05 mb/d
Of the 3.05 mb/d, OPEC opened the choke by 2.46 mb/d after closing the choke by 2.48 mb/d between 2000 and 2002.
Get it now?
Apneaman on Sun, 7th Dec 2014 5:18 pm
The Only Two Charts You Need to Understand the S&P 500
“As long as corporations continue borrowing money to buy back their own stocks and the yen keeps dropping, the SPX will continue lofting higher.”
http://charleshughsmith.blogspot.jp/2014/12/the-only-two-charts-you-need-to.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+google/RzFQ+%28oftwominds%29
bobinget on Sun, 7th Dec 2014 5:53 pm
When KSA made its little bomb-shell announcements, followed up following day by price reductions for the US and Asia, it brought pain and suffering to fellow OPEC members. Russia lured the Saudis into this corner. Rats trapped by greed and superstition.
Answer this;
If prices were too high, (above $150) could the Saudis increase production?
When prices collapsed because of clever PR and market manipulation, did the Saudis cut production?
No on both counts. Ergo, King is Dead.
What the Fing good is a cartel if it can’t control prices. This what cartels are for. Bottom line.
I hate to repeat myself but the absolute fact is.. Iran and KSA are at war, has everything to do
with Saudi Arabia’s fatal decision.
GregT on Sun, 7th Dec 2014 6:07 pm
Both Iran and the KSA are proxies for a much ‘bigger’ war. That war is only an economic war, for now. If TPTB keep pushing, that war will not remain a proxy war, or an economic war, and it should be very clear already, TPTB have no intention of letting up.
Plantagenet on Sun, 7th Dec 2014 6:27 pm
@MKohnen
Do the math! Global oil production is growing and global GDP is growing. The numbers aren’t great, but slow growth is better than no growth.
Cheers!
shortonoil on Sun, 7th Dec 2014 7:00 pm
“Of the 3.05 mb/d, OPEC opened the choke by 2.46 mb/d after closing the choke by 2.48 mb/d between 2000 and 2002.”
Oil production increased by 2.57 mb/d in 2000.
Did you have this kind of problem as a child? Bet you had a big pink rabbit as a friend.
Davy on Sun, 7th Dec 2014 7:15 pm
Planter, I will mention this again:
Hypoxia (also known as Hypoxiation or Anoxemia) is a condition in which the body or a region of the body is deprived of adequate oxygen supply. Hypoxia may be classified as either generalized, affecting the whole body, or local, affecting a region of the body.
This is what is happening with oil’s contribution to the economy. Oil is depriving the global economy of what is required for complexity and growth needed to battle entropic decay and resource depletion.
We are losing the battle but the question is the time frame. Since humans have a disposition for short term time value the key question is will descent happen soon or down the road? For me this is a key question. 10 years has a significantly different feeling than 3 years.
I feel we are on a bumpy descent currently. Economic statistics are not accurately expressing our true condition. The numbers have also been massaged to goal seek growth per the central banks financial forward guidance. The financial repression and debt creation cannot be considered healthy growth. Much of the hyper growth out of China is mal-investment. Then there is the destructive aspects of growth. How can we call the destruction of good farm land for a Chinese toy factory healthy?
I could go on and on with examples of what is considered growth by society but in actuality is an example on entropic decay labeled as growth. This decay is pervasive throughout society, the economy, and the environment.
Apneaman on Sun, 7th Dec 2014 10:16 pm
World Footprint
Do the math! Plant.
Do we fit on the planet?
Today humanity uses the equivalent of 1.5 planets to provide the resources we use and absorb our waste. This means it now takes the Earth one year and six months to regenerate what we use in a year.
http://www.footprintnetwork.org/en/index.php/GFN/page/world_footprint/
trickydick on Sun, 7th Dec 2014 10:29 pm
Peaking and then crashing oil prices foretell a massive recession, a la 1973-74 and 2009-2011. That’s what the historical price charts say, by my interpretation.
Right now, business couldn’t be better. But the same thing could have been said in 2008. The future looked bright back then. The McMansion was here to stay and if you didn’t have one, you needed one. And then the poop hit the fan and big companies started saying things like ‘we no longer provide any outlook to analysts, because right now, there IS no outlook, just a financial cliff’. Remember those days?
antaris on Sun, 7th Dec 2014 10:55 pm
Just like a racing engine. They always run the best just before they blow up.
Apneaman on Sun, 7th Dec 2014 11:02 pm
Oil price drop threatens to reduce revenues at Canada’s top banks
Oil and gas companies form important part of banks’ investment and corporate services client base
http://www.cbc.ca/news/canada/calgary/oil-price-drop-threatens-to-reduce-revenues-at-canada-s-top-banks-1.2863543
Wow! oil and banks need each other. Who woulda thunk it?
trickydick on Sun, 7th Dec 2014 11:54 pm
@Apneaman I like some of what Charles Hugh Smith writes. In this piece about why oil prices falling causes crashes, he answers my financial questions about how that actually occurs. Instinctively, everyone thinks low oil prices are good for everyone. But it’s like houses. Low prices being good depends on which side of the transaction you’re on. For buyers, low prices are good. For sellers, they are bad, assuming that they have to sell. Oil producers generally have to sell what they produce. But being underwater on cash flow is not the worst thing. That can be fixed by shutting down the well and laying off workers. The real problem is the financing that can no longer be paid off. It’s that mortgage that can’t be paid off, so you have to bring cash to the table, but you don’t have any so can’t bring any. So you’re stuck.
These fracking operations require junk bond financing in many cases and that is the thing that must be unwound. If houses were only bought for cash, there wouldn’t be a meltdown when prices fall. We’ll find out how leverage the oil business is soon enough. At a minimum, there won’t be any financing going forward without higher prices. The numbers won’t work for the bond underwriters. http://charleshughsmith.blogspot.jp/2014/12/the-oil-drenched-black-swan-part-2.html
marmico on Mon, 8th Dec 2014 3:37 am
Oil production increased by 2.57 mb/d in 2000.
Of the 2.57 mb/d, OPEC opened the choke by 1.75 mb/d after closing the choke by 1.15 mb/d in 1999.
I’ll lend you a buck so you can buy a gallon to put out the bigger Btu fire with your weenie.
shortonoil on Mon, 8th Dec 2014 7:49 am
But being underwater on cash flow is not the worst thing. That can be fixed by shutting down the well and laying off workers. The real problem is the financing that can no longer be paid off.
Because of the entropic decay of the world’s petroleum reserves, prices reached their maximum level in 2012. The price of petroleum can be no higher than the amount of economic activity that it can power, otherwise the money would not exist to purchase it. That placed the world’s petroleum market in a downward price spiral:
http://www.thehillsgroup.org/depletion2_022.htm
With a declining cap on prices, producers only have one option to maximize their cash flow; produce at a maximum rate! That is obviously the decision that OPEC, and Russia have made. This downward price spiral will continue to put the highest production cost producers out of business. Its impact on the financial industry will devastating!
Hundreds of $billions of forward production has been hedged in the derivatives market. The entire industry, from producers to refiners, use the mechanism. These contracts are often pyramided to multiple levels; the buyer of a contract sells another contact to protect their position. This process may go ten levels deep, and few if any of them actually have the full amount of funds required to cover their positions.
In the event of a major default a daisy chain of claims appears. If one counter-party in the chain defaults none of the buyer/sellers in the chain have the funds to cover their positions. With tens of thousands of participates in the process no one knows who is solvent, and who isn’t. The financial system locks ups, and everyone stops paying their debts.
This occurred in 2008 when Lehman Bros. went under. In that case the exposure was limited enough that the FED was able to rescue the counter parities. The present situation is much bigger. Because the petroleum industry is the largest industry in the world (out side of food production) every pension fund, bank, bond holder, savings account holder, credit card company, and service provider or manufacturer is exposed.
This event could only be avoided if petroleum prices rise. The thermodynamic effects of depletion say that is not going to happen!
http://www.thehillsgroup.org/
rockman on Mon, 8th Dec 2014 8:33 am
As shorty says: “With a declining cap on prices, producers only have one option to maximize their cash flow; produce at a maximum rate!” I’ve made that point many times. On paper one might think most operators would cut production in the face of falling prices. But when you put down debt repayment, overhead costs and drilling budgets on the same piece of paper the possibility of production cuts quickly disappears. Yes: more often then not companies will do what ever they can to increase production.
It reminds me of a photo my first boss at Mobil Oil had hanging in his office. A very old photo of an mule drawn oil tank. One of the 4 mules ways laying in the mud presumably dead. They caption the boss added: “Cut out the dead and beat the others harder”. LOL. Which is right where we are today.
rockman on Mon, 8th Dec 2014 9:04 am
And for the curious: the average nominal price for oil in 1998 was $11.91/bbl. You newbies don’t really know what real pain the oil patch has suffered in the recent past. LOL.
Kenz300 on Mon, 8th Dec 2014 9:22 am
“One of the things a cartel can do–if it controls enough market share–is destroy competition through a price war. ”
This does not seem much different than when the fossil fuel industry tries to limit competition from alternatives. If you have a big enough market share you can manipulate the market…….
That is why there needs to be more competition and more alternatives.
It is time to end the oil monopoly on transportation fuels.
Northwest Resident on Mon, 8th Dec 2014 9:34 am
“It is time to end the oil monopoly on transportation fuels.”
Cue the Twilight Zone theme music.
Ralph on Mon, 8th Dec 2014 10:06 am
Falling oil prices will cut a lot of jobs in the fracking industry. They will cause some oil cos to go broke and a lot of investors to lose a lot of money. This will cause recession and a big drop in oil demand in the US, which is the world’s marginal consumer (ie most profligate and inefficient, and therefore the most sensitive to oil price). This cut in demand, combined with weak demand in Europe, Japan, China, could lead to global oil prices falling further, leading to a deflationary spiral into depression in good ‘ol USA.
Oil , oil everywhere and not a cent to buy it with.
shortonoil on Mon, 8th Dec 2014 11:36 am
Not only are shale producers cutting, but so are the majors. BP yesterday, and Chevron today. We can expect many more such announcements over the next few weeks.
2$ gas is actually more expensive than $3 gas – if you don’t have a job!
ghung on Mon, 8th Dec 2014 2:22 pm
ConocoPhillips Sets 2015 Capital Budget of $13.5 Billion
“HOUSTON – ConocoPhillips (NYSE: COP) today announced a 2015 capital budget of $13.5 billion, a decrease of approximately 20 percent compared to 2014. The reduction in capital relative to 2014 primarily reflects lower spending on major projects, several of which are nearing completion, as well as the deferral of spending on North American unconventional plays.
Despite the lower investment level, the company expects to achieve approximately 3 percent production growth in 2015 from continuing operations, excluding Libya. Key sources of growth include recent major project startups in Canada, Europe and Malaysia, development drilling programs in the Eagle Ford and Bakken, and new production from 2015 major project startups at Eldfisk II, the Australia Pacific LNG (APLNG) Project and Surmont Phase 2.
“We are setting our 2015 capital budget at a level that we believe is prudent given the current environment,” said Ryan Lance, chairman and chief executive officer. “This plan demonstrates our focus on cash flow neutrality and a competitive dividend, while maintaining our financial strength. We are fortunate to have significant flexibility in our capital program. Spending on several major projects has peaked and we will get the benefit of production uplift from those projects over the next few years. In addition, we have significant identified inventory in the unconventionals, where we also retain a high degree of capital flexibility.”
The 2015 capital budget includes funding for base maintenance and corporate expenditures, development drilling programs, major projects, and exploration and appraisal spending. The breakdown is as follows:
Base Maintenance
Approximately $1.9 billion is allocated to base maintenance and corporate expenditures. This is a slight reduction compared to 2014, reflecting lower planned spending in several producing assets across the portfolio
Development Drilling Programs
Approximately $5.0 billion is allocated toward the company’s development drilling programs. This compares to the 2014 budget of $6.5 billion. In 2015, the Lower 48 development program capital will continue to target the Eagle Ford and Bakken, and will defer significant investment in the emerging North American unconventional plays, including the Permian, Niobrara, Montney and Duvernay. The company retains the flexibility to ramp up or down activity in the unconventionals.
Major Projects
Approximately $4.8 billion is focused on the company’s sanctioned major projects. This represents a significant reduction compared to 2014, which included peak spending at the APLNG and Surmont Phase 2 projects. Funding in 2015 will focus on completion of APLNG and Surmont Phase 2, as well as multiple projects in Alaska, Europe and Malaysia.
Exploration and Appraisal
Approximately $1.8 billion is allocated toward the company’s exploration and appraisal programs, down slightly compared to 2014. This spending will focus on conventional activity in the U.S. Gulf of Mexico, offshore West Africa and Nova Scotia, as well as unconventional activity in North America.”
ghung on Mon, 8th Dec 2014 2:23 pm
http://www.conocophillips.com/newsroom/Pages/2014/ConocoPhillips-Sets-2015-Capital-Budget-of-$13.5-Billion.aspx
turningpoint on Mon, 8th Dec 2014 9:46 pm
When I started reading Davy’s response to Plant about hypoxia, at first I assumed he was referring to his mental capacity. Who could blame me?