A worker at a drilling rig in the Permian Basin last year. Picture: Spencer Platt/ Getty Images.
The past week has provided a glimpse into a future of seesawing tensions in the oil market, as OPEC’s attempt to regain control of the price is offset by the impact of higher prices on US shale production.
Last year, of course, OPEC and some key non-OPEC producers led by Russia announced plans to reduce their production by 1.8 million barrels a day in the first six months of this year in an attempt to drive up a price that had been smashed by the 2014 decision to flood the market in an attempt to undermine the economics of US shale.
The history of similar agreements was one of significant noncompliance. While the production cutbacks have only just started it looks, however, as though this time the key producers are delivering on their commitments. Indeed some are over-delivering.
Saudi Arabia’s production has fallen to two-year lows and the reduction is running ahead of the 486,000 barrels a day it said it would cut. Kuwait, Iraq, Algeria and the UAE have also reduced their output.
After the failed attempt to increase their market share and drive US producers from the market rebounded — US shale production fell, but only modestly, while the plunge in the oil price savaged the finances of the oil producers — the stated goal of the OPEC pact is a relatively modest one. The six months of lower production (which could be extended) is designed to reduce the global glut of oil inventories overhanging the market.
At this very early stage there is no sign that is happening. US oil inventories rose in the first weeks of this month. More pertinently, US shale production has risen since the agreements and the rig count is rising rapidly, with more than 200 more rigs back in operation relative to the low point in the middle of last year.
In June last year US shale production had fallen about 500,000 a day from the levels that provoked OPEC’s market share strategy to about 8.5 million barrels a day. It’s now back at about 9 million barrels a day.
The production cuts have pushed the oil price up to around $US55 a barrel, a level at which the more productive shale basins in the US can now generate meaningfully positive cash flows after dramatically lowering their operating costs in response to the plummeting prices.
Some producers in the liquids-rich basis can now produce profitably at prices around $US40 a barrel, with Shell saying recently that some of its wells are profitable below that level.
With thousands of drilled-but-not-completed wells that could be brought into production quickly and relatively cheaply, the US shale sector could very quickly boost its output materially in response to the higher prices.
Overnight ExxonMobil announced it will pay $US5.6 billion to the Bass family, with the potential for a further $1bn, to acquire the billionaires’ interests in the Permian Basin in west Texas, regarded (with the Eagle Ford region) as one of the best shale acreage in the US.
Exxon said the deal — its first big play in shale since the $US30bn-plus 2009 acquisition of XTO Energy marked the oil industry heavyweight’s entry to the sector — would add more than 3.4 billion barrels of oil equivalent to its resources, of which 75 per cent would be liquids. It plans to double the level of drilling activity on the acreage.
The acquisition is an obvious vote of confidence in the prospects for the US shale sector and the Permian, where Exxon is already a major player, in particular. BHP Billiton, of course, has significant holdings in the Permian and Eagle Ford.
The Saudis have expressed a view that the recovery in US shale volumes will be more modest and slower than some are forecasting, with their oil minister, Khalid al-Falih, saying at Davos this week that the combination of the depletion of the more prolific reservoirs and rising costs as the contracts that were squeezed during the downturn demand higher rates meant the US producers would need higher prices if there were to be a big boost to US production.
OPEC has misjudged the resilience, flexibility and capacity to drive productivity gains of US shale in the very recent past but it is probably the case that, outside of the Permian and Eagle Ford, much of the US sector probably needs a price of around $US60 a barrel to reignite large-scale activity.
The outlook for global growth may impact the rate at which OPEC’s production cutbacks impact global inventory levels and determine whether the current agreement has to be extended for a further six months.
That outlook is clouded, with the optimists hoping that the Trump administration can turbocharge US growth, with spill-over effects elsewhere, and the pessimists seeing the potential for rising protectionism and growth-depleting trade wars.
What the past two years have demonstrated is that US shale has become the sector’s swing producer, and its price “capper”, with its ability to switch on and off volumes quite rapidly in response to price movements.
The experience of OPEC’s less-than-successful market share war probably points to a more volatile oil price but one that trades within a narrower range.
OPEC and its allies will work to keep a reasonable floor under the price — around $US50 a barrel, perhaps — while the threat of the US production effectively imposes a ceiling of just under $US60 a barrel until the inventory glut is worked through, and the impacts of the massive cuts to exploration and the development of new oil reserves that have occurred since 2014 emerge.