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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.

Compared with 2007, higher US natural gas production, a portion of which is linked to oil production, is saving American businesses and consumers around $100 billion per year, despite consumption increasing by about 20%–in the process replacing  more than a fifth of coal-fired power generation and reducing CO2 emissions. $25 billion of those savings come from lower natural gas imports, which were also on an upward trend before shale hit its stride.
 
The employment impact of the shale revolution has also been significant, particularly in the crucial period following the financial crisis and recession. From 2007 to the end of 2012, US oil and gas employment grew by 162,000 jobs, ignoring the “multiplier effect.” The latter impact is evident at the state level, where US states with active shale development appear to have lost fewer jobs and added more than a million new jobs from 2008-14, while “non-shale” states struggled to get back to pre-recession employment. That effect was also visible at the county level in states like Pennsylvania, where counties with drilling gained more jobs than those without, and Ohio, where “shale counties” reduced unemployment at a faster pace than the average for the state, or the US as a whole.
 
If the shale revolution had never gotten off the ground, US oil production would be almost 5 million barrels per day lower today, and these improvements in our trade deficit and unemployment would not have happened. The price of oil would assuredly not be in the low $30s, but much likelier at $100 or more, extending the situation that prevailed from 2011’s “Arab Spring” until late 2014. If OPEC succeeds in bankrupting a large part of the US shale industry, we might not revert to the energy situation of the mid-2000s overnight, but some of the most positive trends of the last few years would turn sharply negative.
 
Now, in fairness, I’m not suggesting that this situation can be explained as simply as the kind of old-fashioned price war that used to crop up periodically between gas stations on opposite corners of an intersection. The motivations of the key players are too opaque, and cause-and-effect certainly includes geopolitical considerations in the Middle East, along with the ripple effects of the shale technology revolution. It might even be possible, as some suggest, that OPEC has simply lost control of the oil market amidst increased complexity.  
 
However, to the extent that the “decimation” of the US oil and gas exploration and production sector now underway is the result of a deliberate strategy by OPEC or some of its members, that is not something that the US should treat with indifference.

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.

Content Discussion

Rick Engebretson's picture
Rick Engebretson on March 1, 2016

This article, and that of Amy Myers Jaffe, are important and timely. My take on presidential politics might be relevant. My memory might be VERY wrong, however.

My political awareness was born in 1968, during the VietNam War. Since Hubert Humphrey and Richard Nixon squared off, every election was won by the most convincing peace candidate. Even Nixon, in 1972, persuaded us he would provide a better peace than George McGovern.

Today, the peace (domestic and foreign) promises of the most emphatic peace candidate of 2008 are in shambles. And many look way back to Reagan for a time of transformational peace and innovation. Nobody was fooled by yet another Bush. And Clinton is merely stirring up the same old domestic conflicts, afraid to face her record.

The Saudi kingdom contradicts most every global undertaking. Not just oil.

I have heard the biofuels dismissives more times than I can count on TEC. How are the big EXPENSIVE (economic and environmental) promises from oil, wind, solar, and nuclear working out for you?? When the extraordinary people in the oil industry choose to work with, not against, biologists, we might make some important progress.

 

Bruce McFarling's picture
Bruce McFarling on March 2, 2016

“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 …” shale oil producers were gambling on OPEC continuing to support prices to the benefit of shale oil producers, and lost their gamble.

“I will not act to the benefit of my rivals and against my own long term interests” is not a declaration of war, it is a declaration of common sense.

 

Geoffrey Styles's picture
Geoffrey Styles on March 2, 2016

You’re right about the bet shale producers were making. The fact that everyone else was making the same bet doesn’t change the risk involved. However, OPEC’s shift in their long-standing pattern of behavior, whether out of common-sense self-interest or some other motivation, doesn’t alter the fact that they are attempting to bankrupt competitors in a market that they cannot themselves fully supply. We have well-established names for such behavior, and I’ve used a few them.

It also doesn’t change the fact that for four decades, the fundamental assumption of US energy policy was that we couldn’t drill our way to energy independence, a statement I myself repeated periodicallly only a few years ago. Shale technology has rendered that assumption at least debatable. Perhaps this is simply how the market works and we should let our production fall back to the levels at which imports start to become a problem, again, at which point a different set of companies and their investors will pursue shale vigorously. But wouldn’t it be nice to at least have a well-informed debate about our options, and what is in the best interest of the country, not just today but over the next decade or two? And if renewables aren’t threatened by cheap oil, it’s only because we have committed to extending an expensive set of subsidies targeting specific technologies.

Geoffrey Styles's picture
Geoffrey Styles on March 2, 2016

Rick,

Ms. Jaffe’s post is a timely reminder that oil prices aren’t the only part of the energy context that has changed.

Energy companies should be doing some very deep thinking about what the world and the industry could look like in 10 or 20 years, and how they must change to remain relevant.

As for biofuels, while I don’t dismiss them I am skeptical that they nor any other substitute for oil in its main transportation energy market can ramp up fast enough, at sufficient scale, to head off the future price increases–and reduction in energy security–now being set up by under-investment. The IEA worries about this, too.

Willem Post's picture
Willem Post on March 2, 2016

Geoffrey,

The future growth percentage of gross world product likely will be less than during the past 2 decades.

Europe and Japan have near-zero percent population, real GNP and energy growth, and that little growth is stimulated by near-zero interest rates and quantitative easing. China’s GNP growth, export-dependent, is slowing.

Other areas of the world likly would need to adopt these low growth rates, as they would otherwise not be able to finance future developement.

US primary energy consumption has been flat since about 1998 (17 years), even though population and GNP increased; increased energy efficiency, and shifting from high-energy-intensive goods to low-energy-intensive services likely were the cause.

The above likely will lead to a lesser percentage growth of world energy production.

Rick Engebretson's picture
Rick Engebretson on March 2, 2016

Geoffrey, you are an excellent business analyst covering the oil industry. I am not close to being a business person. I have appealed for a little more science on this site because if we don’t face the problem you outline we all work for the Saudis, Iranians and Russians. We simply don’t have enough cost competetive oil. We do have the world’s leading biologists.

We have seen processed starch from the seeds of field corn, fermented and distilled, producing significant volumes of fuel and feeds in the world’s largest fuel consumer and food exporter. The capability is certainly there. The process, however, is certainly not evident.

I believe our National Security, our economy, and our global environmental concerns combine to move this forward. We certainly have plenty of CO2 feedstock to add value to.

Geoffrey Styles's picture
Geoffrey Styles on March 2, 2016

Well said. At the same time, ethanol isn’t exactly cheap. Setting aside environmental concerns for a moment (GHG balance, nitrogen eutrophication, etc.) its dependence on natural gas for fertilizer and process heat makes it essentially a form of solar-leveraged gas-to-liquids (GTL). Even with US natural gas prices below $2/MMBTU (17-year seasonal low?) and corn under $4/bushel, today’s wholesale ethanol price is the energy-equivalent of $88/barrel.