OPEC's waning power and the production standoff
INSIGHT ARTICLE |
On Nov. 30, 2016, the Organization of the Petroleum Exporting Countries (OPEC) agreed to cut production by 1.2 million barrels per day (bpd) for a six-month period beginning Jan. 1, 2017. Additionally, in December last year, OPEC members persuaded 11 non-OPEC countries, including Russia, Mexico and Kazakhstan, to cut 558,000 bpd of production as well, bringing the total reduction to about 1.8 million bpd.1 As intended, the agreed-upon cuts served to prop up and stabilize the price of oil. However, OPEC has limited mechanisms to guarantee continued compliance, and recent markets have demonstrated a receding confidence in OPEC’s influential abilities. OPEC’s powers are indeed waning, and continued efforts to reduce production will be offset by increased production from the United States and other countries.
As of March 14, 2017, oil had incurred seven straight days of declines, with West Texas Intermediate closing at $47.72–in line with Nov. 29 prices. The steep price declines were a reflection of market doubts that OPEC will extend production cuts past June, and moreover, considerable fear of another looming price war. While a number of countries, like Kuwait, have indicated a willingness to extend cuts, Khalid Al-Falih, the Saudi Arabia’s energy minister warned on March 7 that (the Saudis) “will not bear the burden of free riders,” a reference to the United States and other OPEC and non-OPEC countries taking advantage of buoyed prices.2
OPEC’s March Monthly Oil Marketing Report (MOMR) highlighted that the OPEC Reference Basket (ORB) had risen to $53.37 a barrel by the end of February 2017; its highest price since July 2015.3 However, the same MOMR stated that commercial oil stocks are rising and that Saudi Arabia’s production (based on direct communication) had increased from 9.75 million bpd in January to over 10 million bpd in February.4 This is of particular significance because Saudi Arabia, the most powerful member of OPEC and the country that led the production cut efforts, had previously cut more production than it had originally agreed upon in an attempt to maintain overall production cuts near 1.1 million bpd. Based on January data, roughly 90 percent of the production cuts had been implemented on an overall basis, but this was accomplished by Saudi Arabia overcompensating for underperformers.5 As has been the case with past cuts, a number of countries appear to be “less compliant,” and it is also apparent that Saudi Arabia does not intend to continue carrying the extra weight. Further complicating matters, Nigeria, Libya and Iran have all increased production since the fourth quarter of 2016, as they are exempt from the accord.6
Similarly, Russian production averaged 11.11 million bpd in February; reflecting no further reductions since January and greatly increasing skepticism that Russia’s production cut target of 300,000 bpd (relative to October 2016 production of 11.23 million bpd) will be met by April 2017.7 Russia has so far reduced output by only 40 percent of its agreed cut.8 Given Saudi Arabia’s recent increase, and Russia’s sluggishness, it can be expected that other non-OPEC countries that agreed to production cuts will be relaxed in their compliance going forward.
As some anticipated, the United States and other countries that are not subject to agreed-upon cuts, have increased production and are gaining market share. U.S. oil production has increased in recent months, exceeding 9.1 million bpd in early March 2017.9 U.S. rig counts are rising (at 617 compared to 316 in May 2016)10 and U.S. crude inventories are again near-record levels, regardless of the March 14 API data reflecting a draw for the week.11 According to the U.S. Energy Information Administration, U.S. crude oil production averaged an estimated 8.9 million bpd in 2016 and is forecasted to average 9.2 million bpd in 2017 and 9.7 million bpd in 2018.12
OPEC’s next meeting is May 25, 2017. If OPEC and certain non-OPEC countries agree to extend production cuts beyond June 30, 2017, it can be expected that prices will remain buoyed, and U.S. shale producers will continue increasing production to fill the gap. "It became evident that U.S. shale oil output has become and will remain a new global oil price regulator for the foreseeable future," Russian oil major Rosneft said on March 13.13 Break-even prices have dropped significantly in the United States over the past few years and are now averaging $30 to $40 per barrel, depending upon the play, assuming a 10 percent discount rate.14 Other sources list these breakevens of $35 to $45 per barrel, but regardless of the source, the estimated U.S. breakevens are roughly half of what they were just a few years ago.
Some of the decreases in breakevens can be attributed to improvements in technology (e.g., larger pad drilling, longer horizontals and improved completion techniques) which are resulting in higher initial production (IP) rates and improved estimated ultimate recovery (EUR). However, lower fees paid to oilfield service and equipment (OFSE) firms have played a significant role as well. As a result of weakened demand and heavy competition over the past two to three years, many OFSE companies accepted unsustainable, and at times negative, margins in order to stay in business. Prior to the March price slide, industry experts expected OFSE cost inflation in the realm of 10 to 15 percent over the next year or so.15 This will serve to modestly increase break-even pricing for a number of U.S. plays, but we can still expect increased U.S. shale production and further improvements in technology.
OPEC’s options are limited and its power is clearly diminishing. Its previous effort to knock out the United States has failed and U.S. production will likely continue its advance. If OPEC chooses to increase production, it will further depress oil prices and again make some plays less viable; however, the United States has demonstrated considerable resilience. OPEC members are also victims of their own fiscal budgets, for which oil is a primary revenue source; they have their own breakevens, and they are typically much higher than those of U.S. shale.
2 Saudi Energy Minister: Too Soon To Commit To Extending Production Cut. Matt Piotrowsky. Energyfuse.org. March 7, 2017.
3 OPEC Monthly Oil Market Report – March 2017, p.1. March 14, 2017
4 OPEC Monthly Oil Market Report – March 2017, p.53. March 14, 2017
5 OPEC Achieves Record Compliance with Oil Output Cuts. Experts Ask if it Can Last. Tom DiChrisopher. www.cnbc.com. February 10, 2017.
7 Recent Russian Oil Production Data Confirms Delayed Compliance from Minor Producers. Julia Weiss, Rystad Energy. March 14, 2017.
10 Baker Hughes North American Rotary Rig Count Week of March 10, 2017. Reflects oil-directed drilling rigs. 151 gas rigs were operating as well.
11 Oil Bounces Back As API Reports A Surprise Crude Draw. Julianne Geiger. Oilprice.com. March 14, 2017
12 Energy Information Administration. Short Term Energy Outlook March 7, 2017
13 Russian Oil Major Says US Shale Growth Imperils OPEC Deal. Reuters. March 13, 2017.
15 Point Break: E&Ps Brace For Service Cost Inflation. Darren Barbee. Oil & Gas Investor. February 3, 2017.