Yves here. Some readers took issue with our view that the Saudis, and now OPEC, decision against curbing production to support oil prices, was a classic example of predatory pricing, in which a player produces at an uneconomical cost in order to inflict damage on competitors, force them to curtail operations on a permanent basis, and then harvest higher returns later via having thinned out suppliers. As the post below indicates, it’s now increasingly recognized that the Saudis want oil prices lower, and a big reason is to weaken US shale operators (we also suggested that the Saudis also have geopolitical aims for this move, since the countries that get whacked have either been unfriended by Riyadh or are official enemies).
Analysts have taken almost entirely to discussing the Saudi “fiscal breakeven” which is the oil price it needs to raise enough revenues to funds its government, at $90 a barrel, to contend that the Saudi’s can’t afford to allow prices to remain low for all that long. But the desert kingdom has a lot of unused borrowing capacity and clearly does not see its near-term budget issues as a driving consideration. Ambrose Evans-Pritchard, based on a Citigroup analysis that has been making the rounds, argues that the Saudis have misread US shale economics and also contends that many producers have hedged their output, insulating them from the downdraft. Despite its detail, the Citigroup analysis diverges in so many respects from other accounts that I’d like to see more corroboration (recall Goldman’s similarly celebrated forecast that oil was going to over $200 a barrel. Now the Citi view may have merit, but the realization that shale wells have short lives, at least in terms of major production, was new news in the media as of early 2012. The fact that investors in shale were often still using traditional oil production models up until that time reflects the limited experience with extraction method in these geological structures. Thus while the “short lives” assumption may indeed prove to be an overcorrection, I’m not certain that enough experience is in to speak with confidence about the durability of the “tail” or “legacy” from these wells).
By Andy Tully, news editor for OilPrice. Originally published at OilPrice
OPEC’s decision not to cut production to shore up oil prices drove down the price of oil even further in a strong challenge to American shale oil producers – or, in less delicate language, the start of an all-or-nothing price war.
The immediate result of OPEC’s decision was a further drop in the price of the world’s leading benchmark oil, Brent crude, which lost $6.50 per barrel, falling to $71.25 on Nov. 27, its worst performance in a single day since 2011. Brent soon had a weak rally, raising its value to $72.55.
The price of oil has now dropped by nearly 40 percent since mid-June.
But expect Brent and other crudes to fall again, says Igor Sechin, the CEO of Russia’s government-owned oil company Rosneft. He said the average price of oil could go below $60 per barrel during the first two quarters of 2015.
OPEC’s big decision was not to lower its total production cap of 30 million barrels a day, turning aside pleas from less-affluent cartel members, who said the current oil glut has left them unable to afford to sell their oil at such oil prices. They had urged OPEC to reduce production by 1 million barrels per day.
Abdullah Bin Hamad al-Attiyah, who served as Qatar’s oil minister for nearly 20 years, countered on Nov. 19 that any decision to reduce production should be shouldered by major producers who aren’t in OPEC. “Russia, Norway and Mexico must all come to the table,” he said. He may just as well have included the United States.
All these non-OPEC producers recently have been harvesting oil at record or near-record levels contributing to the global oil glut that couldn’t be remedied by a simple OPEC production cut of 1 million barrels per day.
American energy companies lately have been enjoying a production boom by extracting oil and gas locked in underground shale formations. To get at the oil, though, they must resort to the new technologies of hydraulic fracturing and horizontal drilling. These methods are costly, and most observers say they’re unsustainable if the price of oil fell to or below $60 per barrel.
Jamie Webster, an oil analyst at the consultancy IHS Energy, told the Financial Times that OPEC’s decision was “a very aggressive test for US shale. It’s a new gambit for OPEC to try.” But the test is just as aggressive for other producers, particularly those relying on other expensive extraction techniques necessary for Brazil’s deepwater wells, Canada’s oil sands and Arctic offshore oil.
But US oil companies may be the most vulnerable, according to Leonid Fedun, a board member at Russia’s Lukoil. He told Bloomberg News that even at the current price of slightly over $70 per barrel, smaller companies involved shale extraction are beginning to feel the financial pinch.
As oil prices continue to fall, Fedun predicted, so will the smaller companies. “The [US] shale boom is on a par with the dot-com boom,” he said. “The strong players will remain, the weak ones will vanish.”