The Fuse

OPEC’s Relevance Grows Despite Shale

by Matt Piotrowski | May 31, 2018

Last week, the Democratic leadership in Congress sent a letter to President Trump, urging him to take action to pressure the OPEC cartel to increase production and reduce pump prices for U.S. consumers. Their message came not long after Trump himself tweeted to OPEC, calling out its members for artificially inflating prices. And in Mid-May, the House Judiciary Committee held a hearing introducing No Oil Producing and Exporting Cartels Act (NOPEC) to consider ways to take action to hold OPEC accountable for its anti-competitive behavior.

OPEC is as relevant as ever, expanding its longer-term influence by coordinating with Russia and other producers outside of the cartel.

OPEC’s influence in supporting prices over the last year and a half was not supposed to happen. Numerous headlines in the past three to four years claimed that the growth in U.S. shale production from hydraulic fracturing made OPEC irrelevant. (See here, here, and here for examples). Prices, by many accounts, were to remain low for an extended period of time, and the Saudis were expected to adopt a “free-market” strategy to gain more customers. Even if OPEC were to cut output, said critics, the rapid growth from shale—which some labeled the new swing producer—would simply cause prices to fall sharply again.

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But OPEC is as relevant as ever, expanding its longer-term influence by coordinating with Russia and other producers outside of the cartel. Its significance is evident in policymakers in consuming countries calling on the cartel to increase output to avert prices climbing even higher and market participants hanging on every statement from OPEC ministers. OPEC and its allies (OPEC+) have successfully drawn down commercial inventories to normal levels after a glut persisted since 2014 and changed the market’s entire narrative. Global oil prices have risen by as much as 40 percent since OPEC+ began curbing output at the beginning of 2017. Even though shale growth has exploded (increasing by 1.4 Mbd since January of last year), the price rally still occurred.

Price movements, in either direction, are largely dependent on OPEC’s strategy and verbal intervention.

In recent days, global oil prices have fallen below $80 on news that that Saudi Arabia and Russia may engineer a gradual output increase to calm prices. Producers are reportedly considering adding 1 million barrels per day (Mbd) back to the market. The developments are another reflection of OPEC’s outsized influence—price movements, in either direction, are largely dependent on OPEC’s strategy and verbal intervention. Market watchers overwhelmingly agree that the group has artificially inflated the market. “Such a cartel can drive the prices up with a relatively small marginal decrease in production,” Ariel Cohen, a nonresident fellow at the Atlantic Council, told The Fuse.

Despite comments about increasing supply and the recent sell-off, OPEC+ will likely remain committed to support prices in order to boost cash flow to governments and, in Saudi Arabia’s case, launch its highly anticipated Aramco IPO. The current condition created by OPEC’s actions—a lower inventory buffer—has increased risk in the market at a time of high geopolitical tensions and continued rising demand. “The current level of the market deficit, the robustness of the demand backdrop, and the rising levels of disruptions all set the stage for inventories to fall further all the while OPEC spare capacity is drawn down,” said analysts at Goldman Sachs.

Added supply will likely only offset upcoming losses in Venezuela and Iran, and the global market is forecast to remain in a deficit unless OPEC+ adds more than the 1 Mbd, or demand growth takes a substantial hit. If demand continues on its current trajectory, it will average more than 102 Mbd next year, according to the Energy Information Administration (EIA). As a result, OECD commercial stocks would fall by another 630,000 barrels per day, putting further strain on the market.

OPEC’s role in oil market becomes political again

U.S. consumers will continue to be affected by decisions made in Russia and Saudi Arabia.

As oil prices have risen, more attention has been paid to OPEC’s manipulation. OPEC+ controls more than half of the world’s crude oil supply, and the group may become institutionalized, with discussions of a permanent alliance. U.S. consumers will therefore continue to be affected by decisions made in Russia and Saudi Arabia. Besides deliberately cutting output, a number of OPEC’s members are dealing with production problems that will likely endure (the best example being Venezuela), causing further instability and uncertainty about future supply.

“The oil cartel and its allies wield an unprecedented–and unacceptable–capability to determine energy market outcomes,” Cohen told the House Judiciary Committee at the recent hearing on OPEC.

Current political and market dynamics—with gasoline prices the highest in four years—make it clear that shale was never a panacea. The U.S. is indeed an energy superpower now, exporting more than 2 Mbd of crude and over 3 Mbd of finished refined products, along with an increasing amount of LNG. In fact, U.S. sellers have cut into OPEC’s market share in different regions, including Europe and Asia. Shale’s rapid growth may continue into next year, as many forecast. “It is true, that the prices over $70 a barrel make a lot of US shale profitable, and that serves as a damper on the price increase, but it still does not fully eliminate the cartel price-making power,” Cohen told The Fuse.

Shale’s rise in the past decade or so is a unique occurrence in oil market history, and may not be replicated at the same scale.

Shale’s rise in the past decade or so is a unique occurrence in oil market history, and may not be replicated at the same scale. A number of ongoing questions loom over the industry, particularly that it has not been profitable in its existence. The U.S. doubling its production since 2008 has not shielded consumer exposure to price volatility: The U.S. consumes 20 Mbd, almost double its crude output, and OPEC still accounts for 40 percent of the country’s net imports. Outside of the U.S., emerging market demand continues to rise at a sharp pace. In order for the global oil market to be in equilibrium longer term, it needs conventional production to help meet demand and offset structural declines. Besides above-ground factors constraining production, a long development cycle for conventional projects means it will take years for them to come online.

Shale’s early boom and its dramatic revival shows how far the U.S. has progressed in the area of energy security, but it also reinforces the need to overcome complacency of the past several years. OPEC is not irrelevant, and shale, despite its extraordinary impact, has not insulated U.S. consumers from global oil market threats.