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Is OPEC Washed Up?

Is OPEC Washed Up? thumbnail
  • OPEC’s unwillingness or inability to reduce output to defend high oil prices raises doubts about the cartel’s effectiveness and future.
  • Absent cuts by OPEC, it is not yet clear whether the burden of rebalancing oil markets will fall on shale production or larger, more traditional oil projects.

As oil prices continued their slide following OPEC’s meeting on Thanksgiving Day, speculation has grown concerning whether the cartel might have run its course. Is OPEC now at the mercy of forces beyond its control? Will its apparent strategy, as widely supposed, mainly affect US shale oil producers, or could more conventional, but still relatively high-cost oil projects elsewhere bear the brunt–or OPEC itself?

A quick review of OPEC’s history of reining in production to prop up oil prices reflects a mixed record. At least three distinct episodes come to mind:

  • Following the oil crises of the 1970s the cartel was unable to keep prices above $30 per barrel ($70 in today’s money) in the face of surging output from the North Sea and North Slope, and a 10% decline in global oil demand from 1979-83. By summer 1986 oil had fallen to just over $10, despite Saudi Arabia’s having cut production by up to 6.7 million bbl/day from 1981-85, along with the loss of another couple million bbl/day  of supply due to the Iran/Iraq War. Aside from a spike prior to the Gulf War, oil was rarely much above $20 for the next two decades.
  • OPEC’s response to the Asian Economic Crisis of the late 1990s was more successful. When the growth of such “Asian Tigers” as Indonesia, Malaysia, Singapore, South Korea and Thailand stalled amid contagious currency crises, oil inventories swelled and prices collapsed from the mid-$20s to low teens and less. In March 1999 OPEC agreed to reduce output by around 2 million bbl/day, including voluntary cuts by Mexico, Norway and Russia. Although historical data raises doubts that the latter countries ever followed through on these commitments, this move stabilized prices and restored them to pre-crisis levels by year-end.
  • After oil prices went into free fall during the financial crisis of 2008, OPEC’s members agreed in late 2008 to cut over 4 million bbl/day. They apparently achieved around 75% of that figure. Together with the measures taken by central banks and governments to restore confidence, that was enough to boost oil prices from the low $40s to mid-$70s by late 2009, still well short of the $145 peak in June 2008.

If today’s situation were simply the result of slowing economic growth in Europe and Asia, a temporary cut similar to that of 1999 might have received wider support in Vienna. However, the analogy to the 1980s must have resonated strongly, especially with OPEC’s longtime-but-not-this-time “swing producer”, Saudi Arabia. The Kingdom bore most of the pain then, for little gain. It appears able to weather the current storm, at least financially.

The roughly 4 million bbl/day of “light tight oil” production (LTO) added from US shale deposits since 2008 has certainly depressed oil prices. It’s hard to tell by exactly how much, because the growth of shale coincided with high geopolitical risk in oil markets and a volatile global economy. Superficially, it resembles the supply surge of the 1980s. LTO is also generally understood to be high-cost production. Estimates of full-cycle costs vary widely, from the $60s to $90s per barrel.

These factors support the narrative that OPEC, and the Saudis in particular, might be trying to “sweat” shale producers. It’s even bolstered by forecasts from the US Energy Information Administration, predating the price drop, suggesting LTO production could plateau within a couple of years and decline not long thereafter.

I see two problems with this scenario. First, shale producers have various options for reducing costs, including some that a more receptive Congress might be inclined to facilitate next year. Then there’s the recent history of shale gas pricing. I recall industry conferences in the late 2000s in which speaker after speaker presented curves indicating that the true cost of many US shale gas plays was likely over $6 per million BTUs, and certainly above $5. If that had been accurate, shale gas output should have started to shrink shortly after the spot price of natural gas fell below $4 in 2011. Instead, it has grown by around 13%. This suggests that estimates from outside the shale sector have generally exaggerated production costs that at least one analyst suggests might be as low as $25/bbl on a short-term basis.

If you take a long view, as Saudi Arabia and other Persian Gulf producers arguably must, it’s questionable whether the bigger threat to OPEC comes from shale wells that cost a few million dollars each and decline rapidly, or from large-scale projects that can produce for 30 years. An example of the latter is Chevron’s new Jack/St. Malo platform, which just began production in the deepwater Gulf of Mexico. (Disclosure: My portfolio includes Chevron stock.) This $7.5 billion facility is expected to recover at least 500 million barrels over its long lifetime. Sub-$70 oil surely means fewer such developments will proceed in the next few years, including offshore opportunities arising from Mexico’s sweeping oil reforms. That will have implications for production stretching decades into the future.

The impact of low oil prices could be even more significant for conventional non-OPEC oil production  in more mature regions. Oil investments are expected to fall by 14% next  year in Norway, threatening that country’s energy-focused economy. Prospects in the UK North Sea look no better, with a leading expert warning of long-term damage to the regional oil industry. An announced 2% cut in tax rates on extraction profits hardly seems adequate to offset a 38% price decline since June. As things stand now, voters in Scotland dodged a bullet when they  rejected independence, the economics of which depended in part on a sustained recovery in North Sea oil revenues.

Whether shale producers or large investment projects are squeezed more by OPEC’s decision to stand pat, it could take months or perhaps years for lower production to appear. As Michael Levi of the Council on Foreign Relations noted, we shouldn’t discount OPEC’s willingness to act on the basis of its initial reaction to a crisis. However, history also suggests that even if OPEC ultimately acts decisively to defend its desired price level, the outcome may diverge significantly from what they intend. Energy consumers have more choices every day, and that could be the biggest constraint on OPEC’s market power going forward.

Energy Outlook

10 Comments on "Is OPEC Washed Up?"

  1. Kenz300 on Mon, 29th Dec 2014 7:18 am 

    High cost shale, tar sands and deep water producers will fold first……

  2. Kenz300 on Mon, 29th Dec 2014 7:41 am 


    “Energy consumers have more choices every day, and that could be the biggest constraint on OPEC’s market power going forward.”

    It is time to speed up the transition away from fossil fuels.

    Pope Francis’s edict on climate change will anger deniers and US churches | World news | The Guardian


    Rise Of Bike Trains A Win For Children’s Health, Environment

  3. JuanP on Mon, 29th Dec 2014 11:37 am 

    I think that if KSA is forcing OPEC to maintain production levels to lower oil prices to eliminate competitors with higher production costs, that would be a smart move. Geopolitical considerations may play a role in this decision, too.

    Comparing the economics of shale oil and shale gas while ignoring the liquids associated with shale gas production and their economic value is ridiculous. If it weren’t for those liquids those wells wouldn’t get drilled.

    The author paints a rosier future for US shale oil than I believe we will experience. His claim that other higher cost forms of oil extraction and some older fields and wells might suffer more than shale is valid, though. The North Sea is in deep trouble at this prices.

  4. bobinget on Mon, 29th Dec 2014 11:37 am 

    If today’s Wall Street manipulation isn’t sufficient evidence this current oil price war is in fact war related, not reality based, what more proof then this?:

    Fact: million barrels p/d off line in just the last 48
    hours. Months will be needed to restore Libyan exports, no matter what Islamic faction is trying to govern.

    Remember, the so called world ‘oil glut’ is estimated
    between one and one.five million barrels per day.

    Consumption world wide will grow as much due to lower prices without Putin’s meddling.

  5. Speculawyer on Mon, 29th Dec 2014 4:06 pm 

    OPEC has been washed up for at least 2 decades now. They have been pumping pretty much full tilt except Saudi Arabia. And there is no cohesion, they pretty much all cheat.

    It is nice that some people finally noticed that they are paper tigers.

  6. Perk Earl on Tue, 30th Dec 2014 2:29 am 

    “OPEC’s unwillingness or inability to reduce output to defend high oil prices raises doubts about the cartel’s effectiveness and future.”

    So OPEC doesn’t do what we’d like them to do, namely, cut back on production to reduce supply, thus raising oil price but also losing market share in the process, so we caste doubt on their effectiveness?

    That could be used as a definition of ‘self involved’.

  7. Bart Hendrickson on Tue, 30th Dec 2014 9:33 am 

    I think that oil producers are teaming up to put the screws to Russia because of the Ukraine situation, I can’t believe that all oil producers would ever let the oil price get this low without a purpose behind it, they have complete control and are on the same team.

  8. bobinget on Tue, 30th Dec 2014 3:47 pm 

    Bart, Highly mechanized warfare is THE best
    environment for oil producers. The tighter
    one stretches elastic the greater force expended
    on the return. Simple like borscht.

    As production goes south (Libya). As rigs are laid down, as exploration deferred, CAPEX cut, workers
    fired, etc. Profits for the world’s largest oil companies soar when that elastic lets go.

    This happens so often there’s something called “The Oilman’s prayer” google it

  9. turningpoint on Tue, 30th Dec 2014 7:51 pm 

    “I think that oil producers are teaming up to put the screws to Russia because of the Ukraine situation”

    If OPEC wants to stick it to Russia, it’s not over Ukraine. Maybe KSA wants to stick it to the Shia, they’re oil producers too, and the Russians for supporting Syria.

    Why would OPEC care about Ukraine?

  10. bobinget on Wed, 31st Dec 2014 5:59 am 

    why does turningpoint get it and so few others do?

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