OPEC Opens the Oil Spigots
As expected, the Organization of Petroleum Exporting Countries agreed Friday to maintain crude oil production at 30 million barrels a day. In effect, that means a license for both OPEC and non-OPEC producers to increase output as they see fit. Saudi Arabia intends to continue its price war on U.S. shale that was interrupted by the recent speculative upswing in crude prices.
Oil prices plummeted last year after OPEC, led by the Saudis, refused to cut output in response to a global glut. That has already cost the oil industry about 100,000 jobs and as much as $1 trillion in scrapped investment projects. Yet the main players have only increased output. In April, according to the International Energy Agency, OPEC supply was at 31.2 million barrels a day, the highest since September 2012. That was the 12th consecutive month that OPEC production was above the official 30 million barrel limit, and Saudi Arabia was pumping as fast as it could, keeping its output above 10 million barrels a day.
Its enthusiasm was, however, surpassed by the biggest non-OPEC oil power, Russia. In May, it extracted 10.7 million barrels per day, compared with the Saudis' 10.2 million. It was the first time Russia took the global lead since 2010.
The U.S. oil industry, too, did its best to show it was not intimidated. In May, it produced an average of 9.4 million barrels of crude per day, 2.7 percent more than in January and the most since 1972. That provided a nice backdrop to the gung-ho speech by ConocoPhillips Chief Executive Officer Ryan Lance at this week's OPEC conference. "This business will survive at $100 Brent oil pricing and it will survive at $60-70 Brent pricing," he said, adding that a 15 percent to 30 percent drop in production costs in recent months allows the best U.S. frackers to stay profitable even with Brent crude at $40.
That last bit of bravado is either unjustified or irrelevant to traditional producers trying to put pressure on U.S. shale. The U.S. Energy Information Administration expects U.S. crude production to start going down this month and to keep falling through September before growth resumes. According to analysis by Bloomberg Intelligence, prices predicted by the futures market wouldn't be sufficiently high to get U.S. oil companies to start unsealing drilled but uncompleted wells.
That, however, is hardly a satisfactory result for the Saudis. Like Lance, Saudi Oil Minister Ali al-Naimi is putting on a brave face: On Monday, he said things were moving "in the right direction" and the Saudi strategy was working to reduce supply as demand increased. But he can't really be happy until he's put the upstart Americans in their place.
The biggest obstacle to that is the oil price: It's too high, higher than is necessary to make frackers bleed rather than just squirm. All those production records and the de-facto absence of an OPEC output ceiling have been unable to lower it enough, largely because of speculators. In May, money managers still had a net long position in oil futures and options, expecting prices to rise.
It's hard to find a rational explanation for these expectations. With oil supply still growing faster than demand, it can hardly be sustainable, and the expected U.S. production drop in the summer months won't be big enough to help. The OPEC decision sent the price lower, to below $62 per barrel of Brent from above $65 just two days ago, but that's not a big change, either.
Perhaps Iran will set off the next downward slide if it does a deal with the rest of the world on the future of its nuclear program. Sanctions on the oil industry would be lifted, and Iran would ultimately be able to increase its exports by as much as 1 million barrels a day. Apparently, this wouldn't affect the increasingly fictional OPEC production quota. “You know that production is a sovereign right," al-Naimi said Friday, adding that Iran was free to produce as much as it wanted. In other words, the sky, not 30 million barrels per day, is the real output limit, and the Saudis will welcome anyone willing and able to pump more oil so its attack on frackers can resume.
Both Saudi Arabia and Russia are now prepared for lower prices. The Saudi budget was drafted in December, when the price was about $60 per barrel, but the country can take much more pain thanks to its $731 billion sovereign wealth fund. Russia's budget is based on $50 per barrel, and because the price is higher, the ruble has also been stronger than the Russian authorities want, forcing the central bank to buy dollars and euros. Neither of the oil market leaders wants the pain of last year's price drop to have been in vain, and they haven't secured their market share yet.
For now, financial speculators are playing an outsize role in maintaining the current price equilibrium. Once something spooks them, frackers will be in for another round of shock therapy.
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