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Wednesday, January 13, 2016

Has OPEC's Strategy to Curtail U.S. Shale Been a "Trillion-Dollar Miscalculation?"

From Forbes:
In 1994 OPEC produced 39.9% of the world’s oil. In 2004, OPEC’s share had risen to 42.1% — just before oil prices would go on a run that would take them above $100/bbl. The rise of shale oil production in the U.S. added 4.9 million barrels per day (bpd) of oil to the market between 2008 and 2014, and OPEC’s share of global oil production fell slightly to 41.2% in 2014. (Note that while there was a ban on exports of U.S. oil, the rise of shale oil backed out imports and put that oil on the open market, and exports of finished products from U.S. oil rose sharply over that time period). While OPEC’s 2014 market share was well below the ~50% market share OPEC held prior to the 1973 oil embargo that rocked global economies, it should be clear that with more than 40% of global production, OPEC maintains a position of dominance over the global crude supply. 
Overall, OPEC members produced 36.5 million bpd of oil and natural gas liquids in 2014. When they met in November 2014, oil prices had already suffered a sharp fall from summer, but crude was still trading at ~$75/bbl. The world was probably oversupplied at that time by 1-2 million bpd, so if OPEC had merely decided to remove 2 million bpd off the world markets — only 5.5% of the group’s combined 2014 production — the price drop could have easily been arrested and maintained in the $75-$85/bbl range. That would have still given them 38.9% of the global crude oil market. For that matter, a production quota cut of 13% could have removed from the market a volume equivalent to all of the U.S. shale oil production added between 2008 and 2014. 
Would that strategy have cost them market share? Sure, a small amount. But assume they then pumped 34.5 million bpd at $80/bbl. That’s just over a trillion dollars in annual revenue. If instead they pump 36.5 million bpd at $35/bbl — which is actuallymore than they are getting as I write this — that’s $466 billion in annual revenues. The annual difference in those scenarios is $541 billion. OPEC already lost out on that much in 2015 from the sharp drop in prices. If prices remain at these levels for most of this year, the foregone revenue for OPEC in 2015 and 2016 will easily top $1 trillion since that November 2014 meeting. 
Was this a miscalculation on the Saudis’ part, or is there a deeper strategy at play? I firmly believe they failed to anticipate how sharply oil prices would drop. I think they believed that oil prices could fall somewhat below $75/bbl for a short period of time, and that would be enough to bankrupt a lot of the shale oil companies and allow OPEC to recapture market share. Instead, the shale oil producers slashed costs, and while some producers have gone bankrupt — and other bankruptcies are undoubtedly on the way — shale oil production has proven to be much more resilient than the Saudis and OPEC expected.
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