Shale or OPEC: Who Will Rule the Oil Market?

Historic change of roles is at the heart of the clamour and turmoil over the col- lapse of oil prices, which have slumped below $50 a barrel, the weakest since 2009, trig- gering a price war between producers to secure the oil market with the price outlook remaining grim. For decades, the Saudi Ara- bia kingdom was described as the swing producer of oil because of its immense pro-
duction capacity. It could raise or lower its output to help the global market adjust to short- ages or surpluses. At the last OPEC meeting in Vienna, Saudi Arabia resigned from that role and OPEC hand- ed over all responsibility for oil price to the market, which the Saudi oil minister, Ali Al- Naimi, predicted would stabi- lise itself eventually. Following the death of King Abdullah on Friday, the new King Salman is unlikely to change his country’s policy of flooding the market with oil instead of bowing to pressure
within the Organisation of Petroleum Exporting Coun- tries (OPEC) to ease back on its policy that has resulted in the price of oil falling 50pc in the past six months. Markets are currently flooded with crude, while oil and gas companies are cutting back operations aggressively, which is just what Saudi Arabia had hoped would happen. For now, the only sign that U.S. crude oil production may shrink is the falling number of operational oil rigs in the U.S. It was down to 1750 lastweek, 61 less than the week before and four less than a year ago. Oil output, however, is still at a record level. In the week that ended on January 2, when the number of rigs also dropped, it reached 9.13 million barrels a day, a 44-year high. Oil companies are only stop- ping production at their worst wells, which only produce a few barrels a day — at cur- rent prices; those wells aren’t worth the lease payments on the equipment. Since nobody is cutting production, the price keeps going down; today, Brent was at $48.27 per barrel and trends are still heading downward. All this will eventually have an impact. According to a fresh analysis by Wood Mackenzie, “a Brent price of $40 a barrel or below would see producers shutting-in pro- duction at a level where there is a significant reduction in global oil supply. At $40 Brent, 1.5 million barrels per day is cash negative with the larg- est contribution coming from several oil sands projects in Canada, followed by the U.S.A. and then Colombia.” In the meantime, Saudi Arabia and the Persian Gulf emirates can afford to wait till the lower oil price stimulate economic growth and demand for oil because of their large holdings of foreign reserves.
This is not true for many of the other OPEC members. Venezuela is highly vulner- able to turmoil and even fi- nancial collapse. Nigeria, the largest economy in Africa and the continent’s most populous nation, is also at risk. The oil sector represents 95 per cent of export earnings and 75 per cent of government revenues. And its revenues are falling as it needs more money to fight the Boko Haram Islamist insurgency. This could be a bloody, pro- longed battle with an uncer- tain outcome. Oil supply and demand are rather inelastic to the price in the short term. The price’s trajectory this year will, therefore, be largely dictated by the news and the market’s reaction to it. A wave of bankruptcies in the U.S. shale industry will probably drive it up because it will be perceived as a negative factor for supply. How high it will go, how- ever, is unpredictable. It may actually rise enough to en- able consolidation in the U.S. shale industry, giving it sec- ond wind and driving OPEC countries, Russia, Mexico and Norway into greater difficul- ties — or it might just even out at a level that would make the U.S. forget about its shale boom. That would have dire consequences for the U.S. eco- nomic recovery.