Commodities

Julian Lee is an oil strategist for Bloomberg First Word. Previously he worked as a senior analyst at the Centre for Global Energy Studies.

We had BP's "Beyond Petroleum," now Saudi oil minister Khalid Al-Falih is setting the scene for "Beyond Market Share."

The so-called market share strategy it imposed on OPEC in November 2014, where it decided to defend its dominance by pumping more crude, has worked. The war on high-cost oil is won. Now it's time to win the peace.

You might ask how I can possibly argue the Saudis have won. After all, didn't they just abandon that very same strategy without killing U.S. shale, with their economy buckling under the pressure of sub-$50 oil?

I don't see it like that. I never liked the simplistic view of a battle between Saudi and shale, where victory could only be secured by the industry's destruction. It was always more subtle. As I've written before, the policy was a response to the Saudi realization that, if oil stayed at $100 a barrel, OPEC (which really means Saudi Arabia) would have had to keep cutting supply to maintain prices -- thereby creating room for high-cost oil producers. American shale was only ever the most visible part of that "enemy", but not all of it and certainly not the most expensive.

As Al-Falih said at last week's Oil & Money conference in London, if OPEC had cut output in November 2014 to support prices, it would have had to do so again in 2015 and 2016. Instead, its production has increased by 2.4 million barrels a day, excluding the impact of newly returned members Indonesia and Gabon.

OPEC Market Grab
OPEC's oil production (excluding returning members) has soared under its market-share strategy
Source: Bloomberg

OPEC would never be able to kill shale entirely, only put it in hibernation, and that's really all it needed to do. Much has changed in the two years since November 2014. Back then, U.S. shale oil output was rising by about 1 million daily barrels each year. Now it has stagnated. Sure, growth will return as crude prices recover, but at $60 a barrel it's unlikely to reach anything like 1 million barrels a day.

Slowing Shale
OPEC's market-share strategy brought rampant growth in U.S. Lower 48 oil supply to an abrupt end.
Source: Bloomberg, EIA

We've also seen an almost total halt in big new conventional oil projects. BP CEO Bob Dudley, speaking at the same conference, said he will continue to invest, but only in the "best projects," which probably won't include deep-water frontier exploration. It recently pulled out of such a project off Australia.

We're also coming towards the end of new projects sanctioned before the oil crash. Yes, we've seen some big fields start producing this year, not least Kazakhstan's much-delayed Kashagan. But the number of new fields still to start producing is dwindling.

The oil industry has always been characterized by long lead times and that's still true. The advent of U.S. shale may have sped things up for that part of the industry, but even shale lead times will probably lengthen as it moves beyond its American birthplace.

20161021_OIL

So how does Riyadh secure its victory? If it's genuinely interested in a "stable" oil market -- and I believe it is -- then it needs to look beyond the immediate oversupply, which is slowly correcting, and try to set the terms for future production growth two to three years down the line.

Exxon's Rex Tillerson, also speaking at Oil & Money, said it was "difficult" to see a supply shortage in the next three to five years. That's based on an assumption that a big part of U.S. shale oil supply is viable at $60 a barrel, which may well be where Saudi Arabia is comfortable seeing oil prices end up (the view of one Saudi Aramco director at the conference).

The kingdom is now engaged in the most delicate of balancing acts. It wants a modest price recovery that encourages enough investment to avoid future supply shortages and price spikes. At the same time, it doesn't want to spur another shale oil tsunami. For now, it's walking the line with aplomb, but the real test will come when OPEC meets at the end of November. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Julian Lee in London at jlee1627@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net