OPEC's War on US Producers
The comments of Saudi Arabia’s oil minister at the annual CERAWeek conference in Houston this week provided some sobering insights into the strategy that the Kingdom, along with other members of OPEC, has been pursuing for the last year and a half. Perhaps the ongoing oil price collapse is not just the result of market forces, but of a conscious decision to attempt to force certain non-OPEC producers out of the market.
Notwithstanding Mr. Al-Naimi’s assertion that, “We have not declared war on shale or on production from any given country or company,” the actions taken by Saudi Arabia and OPEC in late 2014 and subsequently have had that effect. When he talks about expensive oil, the producers of which must “find a way to lower their costs, borrow cash or liquidate,” it’s fairly obvious what he is referring to: non-OPEC oil, especially US shale production, as well as conventional production in places like the North Sea, which now faces extinction. If these statements and the actions that go with them had been made in another industry, such as steel, semiconductors or cars, they would likely be labeled as anti-competitive and predatory.
We tend to think of the OPEC cartel as a group of producers that periodically cuts back output to push up the price of oil. As I’ve explained previously, that reputation was largely established in a few episodes in which OPEC was able to create consensus among its diverse member countries to reduce output quotas and have them adhere to the cuts, more or less.
However, cartels and monopolies have another mode of operation: flooding the market with cheap product to drive out competitors. It may be only coincidental, but shortly after OPEC concluded in November 2014 that it was abandoning its long-established strategy of cutting production to support prices, Saudi Arabia appears to have increased its output by roughly 1 million barrels per day, as shown in a recent chart in the Financial Times. This added to a glut that has rendered a large fraction of non-OPEC oil production uneconomic, as evidenced by the fourth-quarter losses reported by many publicly traded oil companies.
That matters not just to the shareholders–of which I am one–and employees of these companies, but to the global economy and anyone who uses energy, anywhere. OPEC cannot produce more than around 37% of the oil the world uses every day. The proportion that non-OPEC producers can supply will start shrinking within a few years, as natural decline rates take hold and the effects of the $380 billion in cuts to future exploration and production projects that these companies have been forced to make propagate through the system.
Cutting through the jargon, that means that because oil companies can’t invest enough today, future oil production will be less than required, and prices cannot be sustained at today’s low level indefinitely without a corresponding collapse in demand. Nor could biofuels and electric vehicles, which made up 0.7% of US new-car sales last year, ramp up quickly enough to fill the looming gap.
Consider what’s at stake, in terms of the financial, employment and energy security gains the US has made since 2007, when shale energy was just emerging. That year, the US trade deficit in goods and services stood at over $700 billion. Energy accounted for 40% of it (see chart below), the result of relentless growth in US oil imports since the mid-1980s. Rising US petroleum consumption and falling production added to the pressure on oil markets in the early 2000s as China’s growth surged. By the time oil prices spiked to nearly $150 per barrel in 2008, oil and imported petroleum products made up almost two-thirds of the US trade deficit.
Today, oil’s share of a somewhat smaller trade imbalance is just over 10%. Since 2008 the US bill for net oil imports–after subtracting exports of refined products and, more recently, crude oil–has been cut by $300 billion per year. That measures only the direct displacement of millions of barrels per day of imported oil by US shale, or “tight oil” and the downward pressure on global petroleum prices exerted by that displacement. It misses the trade benefit from improved US competitiveness due to cheaper energy inputs, especially natural gas.
This is an issue that should be receiving much more attention at the highest levels of government. The reasons it hasn’t may include consumers’ understandable enjoyment of the lowest gasoline prices in a decade, along with the belief in some quarters that oil is “yesterday’s energy.” We will eventually learn whether these views were shortsighted or premature.