Like it or not, looks like the oil price is heading towards $60 per barrel, driven on by OPEC with more than tacit support from Russia. If soundbites received at the conclusion of the International Energy Forum in Algiers on 28 September are to be believed, the cartel is on course to cut production to a range of 32.5 to 33 million barrels per day (bpd) led by Saudis, in a move likely to be supported by the Russians with some action of their own.
Since both the Russians and Saudis have started talking about “prices” rather than production levels, the coming together of Moscow and Riyadh – who between them are pumping over 20 million bpd – along with the rest of OPEC for some good old fashioned market tinkering appears inevitable.
Of course, the so-called lowering of OPEC production – details of which we are unlikely to receive before the conclusion of the cartel’s next summit on 30 November – will most likely exclude Libya, Nigeria and Iran for multitude of reasons ranging from an improvement in security situation in Nigeria and Libya to Iran’s unwillingness to cap its production until it reaches its pre-sanctions level of 4 million bpd.
The illogical assumption is that the Saudis would unilaterally cut their production to make room for OPEC’s first cut since 2008, or Middle Eastern OPEC heavyweights Kuwait and United Arab Emirates would make minor contributions in sync with a bulkier Saudi reduction.
Nonetheless, the market senses it will happen because OPEC’s policy of keeping the taps open, in place since June 2014 when the Saudis insisted on it, has failed to land a fatal blow on US shale players. Bjarne Schieldrop, Chief Commodities Analyst at Nordic bank SEB says, “With several market references to ‘$60 is what US shale oil needs’, it seems OPEC is now naturally aiming for this. Not only has OPEC’s verbal intervention so far lifted crude oil prices higher; by indicating that it is willing to freeze or cut and stabilize the oil market, it has also re-implemented the ‘OPEC put’, taking care of the downside risk.
“With all the pre-negotiations now going on and all the different supportive statements from both Saudi Arabia as well as Russia, it now looks like a fair chance that there will actually be an agreement in Vienna on 30 November.”
However, with the downside risk being taken care of, among those smiling the most are the very shale players stateside that OPEC attempted to knock out of the game. Agreed the oil price, using Brent as a benchmark, is still significantly below $60. However, US shale oil players and Canadian upstarts can lock in new, planned production on the forward curve. This is already reflected in the gradually rising North American rig counts.
Expect more, with perceived reduction in the downside risk as the implementation date of the ‘OPEC put’ draws nearer. From a low of just north of 300 US rigs in May, by the time OPEC’s next summit convenes, we could well be above 500 rigs based on the anecdotal evidence I have from selected law firms in Chicago and Houston, central to the paperwork for drilling permits.
A key variable keeping costs down stateside has been the frugal delivery of oilfield service (OFS) firms, says Deborah Byers, Oil & Gas Leader and Managing Partner of EY’s Houston, US office. “The contribution of OFS firms cannot be understated when we discuss how lower oil prices failed to deliver a fatal blow to North American production. In an era of low prices, evidence suggests OFS companies have compromised on their profit margins over the short-term to deliver lower drilling costs for their customers.
“But more importantly, they are hugely motivated by efficiencies because project sponsors are telling them ‘we do not want the cost of your services to rise when the oil price bounces back’. I’d say as high as 75% of efficiency and engineering gains would be permanent regardless of what kind of oil price environment the market finds itself in 12 months time.”
Furthermore, Byers reckons the tenacity of OFS firms and independent oil upstarts with viable shale plays have ensured drilling costs are down by as much as 30% on an annualized basis in the case of some ventures.”With everything from digital to robotics being applied in an effort improve process efficiencies and reduce drilling time, some of the cost deflation is likely to be permanent, in tandem with more consolidation in the OFS sector.”
Given such a setting, should OPEC and Russia conspire to ensure a $60 oil price becomes the short-term normal, North American producers would more than manage by putting on hedges that give them much needed certainty of cash-flow.
Sooner, rather than later, this would once again put downward pressure on the oil price, oversupply sentiment would return, number of barrels in the global pool will rise and we would be staring at a $40 oil price again. The jury is still out on whether OPEC and Russia’s move would first off take place with a cut of at least 1million bpd; a level deemed meaningful enough by the market, and secondly work the way they expect it to. However, one thing is certain, US shale producers will ensure supply and demand economics would reign supreme sooner rather than later.