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Shale Rivals OPEC As Swing Producer

Shale Rivals OPEC As Swing Producer

Could U.S. shale rival Saudi Arabia when it comes to playing the role of swing producer?

Saudi Arabia has long been the only real oil producer in the world that could ramp up or down its production at a moment’s notice. This is due to its very large oil production capacity that is usually not fully utilized. In other words, Saudi Arabia has the ability to produce much more oil than it does in any given year, with this latent “spare capacity” reserved for times of need.

Spare capacity lies at the heart of Saudi Arabia’s inordinate sway in global oil markets, and has underwritten OPEC’s historic influence over the price of oil. In extreme cases, such as the 1973 oil embargo, OPE C cut off oil exports to several western countries, causing prices to quadruple. A decade later, Saudi Arabia punished fellow OPEC members by ramping up output to crash prices and gain back lost market share.

Although those are dramatic cases, since then OPEC (more or less at the will of Saudi Arabia) has tweaked output to hit certain price targets, but adjustments were largely possible because of Saudi Arabia’s deep capacity reservoir.

In the 2000’s, things changed a bit. The significant run up in prices through 2008, and then once again during the period of 2011-2014, came even as OPEC drew down on its spare capacity. In fact, the price spike in 2008, and to a lesser extent several years later, coincided with lower than average spare capacity levels (see EIA chart).

OPEC spare capacity and oil prices

The 2014 oil bust offered OPEC the option of cutting back production – as it did numerous times in the past – in order to provide some price support for oil. OPEC, seemingly fed up with rising U.S. shale production, instead opted to leave its output levels unchanged. Saudi Arabia, if not other OPEC members, felt it could outlast high-cost shale producers.

And that is likely the case in the short-term. Shale production is indeed much more expensive than oil from the Arabian Peninsula. More importantly, small and mid-sized companies, with impatient shareholders, cannot wait out a price collapse the way Saudi Aramco can. And there is no $700-billion-dollar fund that shale producers can tap into to stay afloat, unlike the Saudi Kingdom.

Nevertheless, while individual shale companies will certainly burn out and fold up shop, collectively they may act as a second major spare capacity player. The International Energy Agency (IEA) released a report that suggests shale production will bounce back when oil prices rise. The IEA expects U.S. shale production to contract towards the end of this year, but could rebound in subsequent years as prices rise, particularly beginning in 2017. U.S. shale will then rise to 5.2 million barrels per day by 2020, up from just 3.6 million barrels per day in 2014.

In contrast, a Citigroup report predicts that oil prices will crash again soon – perhaps as low as $20 per barrel – in large part because shale producers will resume drilling when prices come back up. That complicates the narrative that oil prices are in full rebound mode, and Citigroup predicts it will be more of a seesaw effect – bouncing up and down over the next several months and even years.

Although those two reports differ on the direction of oil prices in the short-term, they both underscore the flexibility of shale. With the oil bust, U.S. production is expected to contract, leaving latent production capacity in the ground. Unlike conventional fields, shale wells can be drilled quickly, and can be shuttered quickly. That makes U.S. shale, “as close to inventory-on-demand as oil ever comes,” as Steve LeVine at Qz.com puts it.

This may not present the “existential threat” that Citigroup suggests, nor will it be “the end of OPEC.” OPEC is still exacting a very large influence over the price of oil. And whereas OPEC spare capacity can be directed by decision-makers at the top, shale output will fluctuate depending on the price of oil, outside of the control of market producers. But by having developed several million barrels per day in “spare capacity” that dozens of shale drillers collectively form, shale is acting as a swing producer.

By Nick Cunningham of Oilprice.com




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  • Mario on February 10 2015 said:
    Isn't the problem with that analysis that it ignores the steep declines in shale. Once you are off the treadmill, its tough to make up the ground you are losing due to very steep first and second year decline rates.
  • Roger Wren on February 10 2015 said:
    A large majority of shale producers must borrow from banks to drill new wells. The banks will be unlikely to loan money to a shale producer until the price of oil is well over that producer's break even point. If a shale field has a break even point of 70 dollars a barrel would you, as a loan officer, be eager to finance new drilling if the current price received (less than the WTI price) was 73 dollars a barrel? What happens to the loan (and your job) if oil drops to 60 dollars a barrel?

    Entire shale fields will not switch on to massive drilling the day oil gets to the break even point.
  • Christoph Weise on February 11 2015 said:
    The very nature of shale is evidently not suitable for swing production. New projects shall require new financing and the availability of new financing is very questionable after the Saudi-Arabians and Russians are done with the US and Canada shale and tar sand producers.
  • Ross E on February 11 2015 said:
    US Oil Tactics
    I am wondering why most people have not clued in on the collusion angle between Saudi Arabia and the US to drive down prices.

    Think about it, John Kerry visits Saudi Arabia just before all of this came down.
    Think about it, how much oil does the US export versus what it imports (virtually no exports)?

    Think about it, how long does the US take to de-mothball a bunch of rigs or drill new holes (not long, now that the US considers they to be "swing producers")?
    Think about it, which country stands to benefit the most from low oil prices other than China - the USA! They are saving more than $200,000,000.00 per day (I am not a futures expert, but money will be saved eventually, even if not quite to that extent). Boy, what a way to kick start the economy too!

    Think about it, which country stands to benefit by thwarting the oil development plans of Canada - the USA. They would rather face a harsher environmental reality of rail shipments then a pipeline. Not even caring about future relationships with their nearest neighbor. Obama has said that “no Canadian oil is going to leave our shores”, or something very similar.

    Think about it, which country stands to benefit from the downfall of other countries, other than Canada (Russia, Argentina, etc.) - the USA! Ultimately they may want to become oil exporters and want to do it at the expense of other ruined economies. And they want to export natural gas and condensates too.
    Wow! I could go on all day. Some of what I say may be a bit far-reaching, but we will see how much of this truly unfolds and comes true in the next two-three years.
    This leads me to two conclusions:

    1) The Americans are trying to become exporters at the expense of other hurting oil producers,

    2) Or, maybe the US is in more dire straits then they truly want to admit and fracking is an illusion that they can turn on the unsuspecting oil producing community every time the prices come too high. I remember Obama saying a few years back that the US “will not pay no $100 per barrel for oil”.

    I've said before, the US would have come crawling to Canada one day for its oil, but it’s easier on their terms if they come to Canada as Canada being a desperate, financially hurting country. They can negotiate better to their own terms.

    I think fracking is hurting them. It’s destroying their watersheds, using up their water and many of the producers are over-leveraged. If OPEC really wants to hurt the US shale market, maybe they should cut their production just enough to get oil back to where the US will go gang busters on shale but not make shattering profits. Then when they run out around 2020, OPEC would have more finite control. What if the shale oil is just a smoke screen to get the Americans oil imports cheaper and buy them some time to rebuild their country and economy? And then maybe too they won’t have to turn their much needed food crops into ethanol (and that’s another whole story, folks).
  • John on February 11 2015 said:
    I would merely ask one of you "anti-US" posters to please explain - very simply - why US shale production is, in fact, NOT the fundamental game-changer that it now very much seems to be.
  • a alhajji on August 25 2016 said:
    Shale cannot be the swing producer. There is a very specific definition of a swing producer in the economic literature. without getting to technical details, here are some conditions that fit only Saudi Arabia:

    Shale as a swing producer?
    1- A swing producer has to be a price maker. Shale producers are price makers
    2- A swing producer has spare capacity that can be brought on line quickly (maximum of 90 days), shale producers are not able to meet this condition.
    3- Shale takes time. There will be a time when producers have to wait several weeks to get a fracking crew
    4- There are technical issues related to elasticity. Shale producers do not meet this condition.


    However, the shale revolution split OPEC into two halves and hit the strategic objectives of the Saudi energy policy:

    https://www.project-syndicate.org/commentary/saudi-arabia-oil-market-dominance-by-a--f--alhajji-2015-03?barrier=true

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