Fifty is only half as good as one hundred, but it’s twice as good as twenty-five. That’s how anyone who is anyone in the international oil business saw it earlier this week when they gathered in Houston for the annual CERAWeek conference sponsored by HIS Markit, the data and information firm. They were referring to the per-barrel price of crude oil, of course. When they gathered last year, prices hovered around $25 per barrel as the Saudis sought to drown the U.S. shale oil industry in cheap Saudi crude. New year, new oil minister. Khalid Al-Falih, now in charge of Saudi policy, has whipped other producers into line to cut back production, and the mood as the conference opened was “ebullient, buoyant, hopeful,” James Carr, Canada’s natural resources minister, declared. Bob Dudley, CEO of BP, announced he is planning that prices will hold at $55 to $60 for the next five years, high enough to allow him to maintain capital spending at current levels, rather than continue cuts that have caused him to sweat 30 percent out of his capital budget since the oil price collapse of 2014. “What a difference a year makes”, enthused one oilman.
Alas, what a difference a day makes. On Wednesday, the unopened champagne bottles were returned to the coolers. The U.S. Energy Information Agency (EIA) announced that crude oil stockpiles are at record levels after jumping in the past month by 8.2 million barrels, rather than the 1.7 million barrels experts had forecast. Prices fell by about 7 percent, more than $5 per barrel, to below $50, as fears grew that the agreement by OPEC members and 11 non-members, including Russia, to rein in production is failing to prevent a continued over-supply of crude. That’s one reason ConocoPhillips CEO Ryan Lance is betting prices will be “lower for longer … [it’s a] “well-supplied world out there.”
To add to the darkening atmosphere, Falih weighed in with the news that his country would not indefinitely attempt to correct the over-supply by cutting back its own production. Falih remains cautiously optimistic that this week’s price plunge is nothing more than a “short-term aberration”, what Ben van Beurden, Shell CEO, calls “ridiculous volatility”. But, he warns, “My optimism should not tip investors into what I would call irrational exuberance or wishful thinking that OPEC or the Kingdom will underwrite the investments of others at our own expense and long-term interests …” A temporary glut is one thing, “intervention in response to structural shifts is largely ineffective.”
One “structural shift” is the diminished power of OPEC. When the cartel and 11 non-members agreed to limit output by 1.8 million barrels per day (mbd), the non-members agreed to cut their output by 600,000 barrels daily. But they have managed only a 400,000 cut, with Russia reducing its output by only one-third of the amount it had pledged to take off the market, reflecting Putin’s need for cash to finance its foreign adventures. And although OPEC in total has made 94 percent of the reductions it promised, it took a decision by the Saudis to double its own agreed reductions to produce that result. Little wonder Falih’s patience is running thin.
The second structural shift from the days of OPEC dominance and $100 oil is the emergence of America’s fracking industry. Scott Sheffield, CEO of Pioneer Natural Resources, is known as the “King of the Permian Basin”, the giant oil field that sprawls across the western part of Texas and the southeastern part of New Mexico. Since 2015 the Permian Basin has accounted for 70 percent of the new oil that has come on stream in the U.S. Sheffield says the Permian holds 75 billion barrels of oil, a treasure trove exceeded only by the Ghawar field in Saudi Arabia, the largest in the world.
The Saudis have undoubtedly noticed that U.S. output is up 600,000bd from its low point, and that exports of crude oil have gone from essentially zero to over 1mbd, the latter offsetting over 60 percent of the 1.6 mbd the Saudi-led cuts have kept off the market. According to Tom DiChristopher, who covers energy for CNBC, “Rising American output is confounding efforts by OPEC, Russia, and 10 other exporters to reduce global oil inventories by curbing their own output.”
Worse still for the Saudi-led cartel, Permian output has nowhere to go but up, and quickly. According to Baker Hughes, the oilfield services group, the number of rigs drilled to create the wells used for oil shale production has more than doubled since May 2016, from 248 to 513. Chevron plans to step up Permian production by 900,000bd in the next few years. Exxon will spend $5.5 billion this year to increase its output in Texas, New Mexico, and North Dakota from wells it reckons can produce a profit at a price of $40 per barrel, and plans to increase its production from those areas by 500,000bd by 2025. Sheffield is even more bullish about the ability of producers to continue to drive down costs: he says Permian oil can generate a 10-15-percent return even if oil prices tumble to “sub-$30” per barrel.
Falih has issued a warning to American oil companies. The Saudis will tolerate an increase in U.S. production of 3-5mbd, but only if that increase occurs “over a number of years” to make up for declines in production in the North Sea and from Mexico. Unfortunately for the Saudi minister, antitrust laws prohibit American companies from agreeing amongst themselves to control output in order to shore up prices. Which means they had better ignore Harold Hamm, CEO of Continental Resources, who some eagle-eyed antitrust enforcer might take to be signaling for collective action to shore up prices. Hamm told the CERAWeek conference that U.S. producers “have the potential to oversupply the market and we have a great responsibility not to do so.” It is likely that Chevron, Exxon, and lots of other producers will keep pumping until the price falls far enough to force the highest-cost producers to cut back output or file for bankruptcy, the latter an experience that would not be a new one for many of them.
Which leaves the Saudis in an especially awkward position. They are preparing an initial public offering of a 5-percent stake in state-owned Saudi Aramco, an enterprise they expect will be valued at around $2 trillion, the funds to be used to diversify the nation’s economy. A world-wide price war at the time of the IPO would be more than little inconvenient. But with Iran, a sworn enemy, using cash provided by President Obama and the relaxation of sanctions to increase its production capacity; Iraq in the process of boosting its capacity another 500,000bd or so and increasingly under the control of Iran; and U.S. producers ramping up Permian production as well as output in other areas, the road to the IPO might prove to be a bumpy one.
We do not know whether this troubling news has been relayed to King Salman, out of the country on an Asian tour, accompanied by an entourage of 620, including 25 princes, and toting—well, not personally toting—460 tons of luggage.
