Houston-based Accumyn Consulting.
The
crude oil market has been like the Texas floods of late — too much oil since 2013, too much rain this spring, and we are dealing with the consequences. No mortal could stop the floods in Texas, and OPEC could not stop the oil flood. U.S. shale had changed the game.
OPEC declined to act as the swing producer because it could not stop the unprecedented increase in world petroleum
stocks (crude plus liquids), leading to May’s market surplus of 3 million bbl/day.
The excess crude oil came from U.S. shale fields. From January 2011 to January 2015, tight oil production from U.S. shale fields increased from 1.0 to 4.5 million bbl/day. In the same period, OPEC’s production fell by 0.3 percent and its market share fell from 43.2 percent to 41.2 percent, a drop representing 1.6 million bbl/day. OPEC may have held the price up until last June, but it couldn’t stop price from plummeting thereafter, as world stocks rose to unprecedented levels.
Had OPEC continued to cut production, keeping price up, U.S. shale producers would have continued dramatic growth. Where would it have stopped? With high prices, OPEC supply cuts would have been replaced quickly by U.S. tight oil production.
Instead, in November, OPEC surprised the market, changing it’s focus to market share. Price plummeted 24 percent in 18 days, bottoming out on March 13 at $43.39/bbl. U.S. oil rigs dropped from 1,575 on Dec. 5 to 635 on June 12, a 60 percent drop.
OPEC realized it could no longer divert price in a flooded market, acting alone. Now, shale producers must transition from price takers into swing producers, making decisions that collectively but independently help correct market imbalances and dampen market price swings. Here’s how they can and what the threats are:
1. Accept the swing-producer role
When price changes trend, shale producers need to adjust production in the same direction within one to three months of a price swing, as OPEC did.
Eagle Ford shale production shows decline rates steep enough to brake production quickly: down 28 percent from first month to third, and 50 percent to sixth. Shale production leveled out in April this year, four months after price and rigs plummeted, and has started to decline. While shale can help, shale isn’t big enough yet to swing production alone.
2. Keep pushing on costs, technology and production efficiency
The shale revolution came about from technology breakthroughs and methodology improvements. Keep pushing the envelope to improve efficiency, reduce costs and increase swing production ability.
3. Be realistic about price
U.S. shale producers can no longer be price takers, comparing current prices to their
breakeven prices.
Shale producers must understand how price behaves. They can use a simple idea — a “shale threshold price ratio” to inform their price expectations. It is the current price divided by their average breakeven price. If the ratio is high, expect the current price to fall soon and quickly, as shale production ramps up. If the ratio is closer to 1, expect it to come down more slowly.
Use these new price expectations to evaluate new
investments and capital decisions. It’s simple, and introduces caution. It’s hindsight, but with better informed expectations, producers may have avoided some of the bigger risks of the last five years.
4. Be cautious about antitrust
Producers need not collaborate about production decisions. What matters is sound price expectations and how producers use them.
5. Understand threats
Market forces beyond producer control affect price, such as geopolitical events and supply disruptions. Producers will form better price expectations if they stay current on expected impact and duration.
The biggest threat is continued excess supply and yet lower prices. With cost reductions up to 30 percent per well, current shale breakeven prices range roughly from $25/bbl to $90/bbl, with most between $45 and $80. A price of $30 would pretty much shut shale down. If price stays above $50, U.S. producers can help by swinging shale production.
Practical and operational issues will challenge the entire U.S. oil industry – storage, downstream,
trading and capital market firms will also need to adjust to a new way of doing business.
Finally, since neither OPEC nor the U.S. can swing production alone, OPEC must help.
By the Numbers
47% — How fast U.S. shale fields increased at an annual rate from January 2011 to January 2015 — they went from 1.0 to 4.5 million bbl/day
0.3% — How much OPEC’s production fell in the same time period — and its market share fell from 43.2% to 41.2%
1,575 — Number of U.S. oil rigs on Dec. 5
635 — Number of U.S. oil rigs on June 12 — a 60% drop
Source: Accumyn Consulting
Laurance L. Prescott is an associate director of Houston-based Accumyn Consulting.
Why OPEC's losing its ability to set oil pricesHailey Lee |
@haileylee139Monday, 27 Oct 2014 | 5:22 PM ETCNBC.com
61COMMENTSJoin the Discussion
OPEC's glory days of steering global oil prices may be at an end.
U.S. shale oil will replace the Organization of the Petroleum Exporting Countries as the first-mover "swing producer," according to a Goldman Sachs report from the weekend—meaning OPEC is losing its power to set global prices for crude.
Saudi Arabia, the world's largest oil exporter, no longer has "the ability to push prices lower than the production costs of U.S. shale" because any cuts from the kingdom would "accommodate the further expansion of U.S. shale, as well as reduce Saudi profits," Goldman said.
The shift in pricing power became apparent to Goldman when U.S. shale's spare capacity, at around 5 million barrels per day, exceeded
Saudi Arabia's spare capacity of 1.5 million. Spare capacity refers to the amount of crude a country is able to produce in 30 days in case of an emergency.
Read More
'Bipolar' markets lose the fear; are they ready to relax?This trend has been a long time coming, but the tipping point started this year with significant cuts in West African oil exports to the U.S., said John Kilduff, energy analyst and founding partner of commodities investment firm Again Capital. U.S. shale oil
has replaced West African imports,
which have been redirected to Asia.The balance was further tipped toward the U.S. when
production rebounded in
Libya and
Iraq despite political instability, adding to an already oversupplied market, Kilduff added.
OPEC pumped 30.6 million barrels of crude oil per day in September,
a jump of 400,000 barrels from August that was driven by the Libyan output rebound, found Platts, a global energy information service.
Read More
Despite washout, hedge funds not bailing on energyOPEC's loss in pricing power is a consequence of not taking U.S. producers more seriously and cutting prices earlier for clients, said Phil Flynn, senior energy market analyst at Price Futures Group.
"Only a year ago, OPEC was still in denial, but with the slowing global economy, they can't laugh off U.S. production anymore," Flynn said.
By 2019, U.S. shale oil production will
jump to 9.6 million barrles per day, from 8 million now, according to forecasts from the Energy Information Administration. In comparison, Saudi Arabia currently produces
9.6 million barrels of crude oil a day.OPEC’s next move
All that said, market watchers across the board expect OPEC to remain
highly influential when it comes to the price of oil.The group will likely cut production when the core countries meet in Vienna on Nov. 27, according to Kilduff. "OPEC is in the process of playing chicken with the market," he said. "But their hand will be forced and they will eventually cut, with the Saudis taking on the bulk of it."
OPEC has absorbed lower oil prices up until this point, declining to cut output in a bid to maintain market share.
Read More
How the US shale boom will be felt around the world"The main reason why OPEC is not cutting production is they realize that U.S. shale is a serious threat to their global oil space," Flynn said.
The cyclical nature of the oil industry makes it unlikely that OPEC has lost its price-setting power permanently, Kilduff said: "There's a boom, bust and a new era upon us all the time. So, the jury's still out on the long-term sustainability of U.S. shale production."
Hailey LeeNews Associate