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Roger Andrews

Roger Andrews

Roger Andrews is a retired mining geologist and geophysicist. Born in the UK he spent most of his professional career in Australia and the USA.…

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Oil Wars: Why OPEC Will Win

Oil Wars: Why OPEC Will Win

In the green corner we have the US shale producers. In the red corner we have the oil exporting countries of OPEC. Assuming the fight is fought to a conclusion, who wins?

OPEC wins. The US shale producers will shut down first. The reasons are:

• The US shale producers are motivated by economics, and all other things being equal will have an incentive to cut production at or around the point where production cost exceeds sales price.

• The OPEC countries are motivated by social imperatives. They have historically used their oil wealth to finance social programs, build infrastructure and subsidize basic foodstuffs and other items such as gasoline (which costs one cent/liter in Venezuela). Cutting back on social spending courts civil unrest and cutting back on oil production cuts spending, so they have a disincentive to cut oil production. (As long as the oil price exceeds cash production costs, which it does in all OPEC countries by a substantial margin, they in fact have an incentive to increase production).

But not all OPEC countries are created equal. Some can stand the pain longer than others, and here we will look into the question of who might go to the wall first if low oil prices persist.

Related: Oil Price Tumbles After OPEC Releases 2015 Forecast

But first the US shale producers. The recent graphic from Business Insider reproduced in Figure 1 is not backed up by much in the way of explanation but my understanding is that it shows current production and breakeven production costs at US shale oil plays based on Citigroup estimates. If we take these results at face value we find that almost all US shale oil production is economic at crude prices of $70/bbl, but 40% of it becomes uneconomic at prices below $60/bbl and almost 90% of it at prices below $50/bbl:

US Breakeven By Shale play

Figure 1: Breakeven production cost estimates, US shale oil plays

Keeping these results in mind we will now move on to the OPEC countries. They have two different production costs. One is the cash production cost, which is usually much lower than the cash production cost in US shale plays. The other is the “budget breakeven” cost, which is the oil price needed to cover production costs plus social spending and which is usually considerably higher than the cash production cost in US shale plays. Figure 2, which superimposes the approximate 95% range of US shale play production costs (from Figure 1) on 2012 OPEC production and budget breakeven costs, summarizes the situation. If production cost was the only thing that mattered to OPEC the US shale producers would rapidly go under:

Breakeven Costs For Selected Producers

Figure 2: Budget and production breakeven cost, OPEC, Russia and US shale oil plays (Original graph credit Agora Financial and Total S.A).

OPEC’s production and budget costs are, however, not well-defined. The table below summarizes the results of my search for hard numbers to use in the analysis:

Production Cost Estimates

Having no particular reason to prefer one set of estimates over any other I discarded all of them and used the “oil price needed to balance fiscal 2015 budget” numbers provided by the Wall Street Journal, which a) are from a single source, b) cover all the OPEC countries, c) are broadly in line with the budget breakeven numbers in the Table above and d) are specific to 2015 budgets. Here are the estimates:

Oil Price Needed To Balance Fiscal Budget

It’s important to note here that these estimates are not the same as the OPEC countries’ “official” budget estimates, which are generally lower and already being lowered further (Iraq has already cut its 2015 budget estimate to $70/bbl and is now considering a further cut; Venezuela is reportedly down to $60). However, they do provide a fixed point of reference that we can use to evaluate relative exposure.

Note also that a non-OPEC country –Russia – appears at the end of the table. I added Russia to the mix because it’s a major oil exporter that finds itself in a similar position to the OPEC countries. The $100/bbl number comes from the Moscow Times.

A simple way of gauging a country’s overall exposure to low oil prices is to calculate the percentage of its GDP supplied by oil export earnings. This, however, is not a straightforward exercise in practice because different data sources sometimes give wildly conflicting figures. For example, the 2013 nominal GDP of Venezuela was $US 227.2 billion according to the IMF and $US 438.3 billion according to the World Bank, and according to OPEC 2013 oil export earnings in Angola were $US 68 billion but only $US 27 billion according to EIA. The numbers I used were derived as follows:

GDP: I used the median value of the three 2013 nominal GDP estimates given by Wikipedia plus the 2013 nominal GDP estimates from OPEC (link below).

Export earnings. I used the 2013 estimates from the OPEC 2014 Annual Statistical Bulletin. As noted above these are sometimes quite different to the numbers given in the EIA’s OPEC Revenues Fact Sheet but they are comparable to the numbers I backed out of the BP 2014 Statistical Review (earnings = production minus consumption times price). The estimate for Russia is from EIA.

Oil export earnings as a percentage of GDP are summarized in Figure 3:

2013 Oil Export Earnings as % Of GDP

Figure 3  Kuwait is the most oil-dependent economy, closely followed by Libya and Angola, and Russia the least oil-dependent. The estimates for Libya and Iran are distorted by civil unrest and sanctions but by how much is hard to say.

A more complex question is the impact low oil prices will have on national economies. Impacts will, of course, vary depending on the specific circumstances of the country, but since a detailed country-by-country analysis is beyond the scope of this post I performed a simplified analysis using the following assumptions:

• Base year 2015

• The volume of oil exports in 2015 is the same as in 2013

• Budget deficits at different assumed oil prices can be calculated as the difference between the price/bbl needed to balance the 2015 budget and the assumed oil price, times oil export volume.

The results at $70/bbl oil, with the deficits expressed as percentages of GDP, are shown in Figure 4:

Annual Budget Deficit As % Of GDP

Figure  4 Kuwait and Qatar have no deficits because their budget breakeven prices are lower than $70. Ecuador, the UEA and Russia have minor deficits. Nigeria, Iran, Venezuela, Iraq, Algeria, Angola and Saudi Arabia have significantly larger ones. Libya looks hopeless.

And at $50/bbl oil (Brent is at $63/bbl as I write) the situation begins to look bleak for Angola and maybe Saudi Arabia as well:

Annual Budget Deficit As % Of GDP $50

Figure 5  These results are semi-quantitative at best, meaning that there is no certainty that Angola would in fact suffer a 25% budget deficit should the oil price stay at $50. However, they do provide a measure of relative risk, and the indication here is that Angola, Saudi Arabia and Iraq are potentially a lot more vulnerable to protracted low oil prices than Ecuador, Russia and Kuwait.

Related: Why US Shale May Fizzle Rather Than Boom

But this does not necessarily mean that Saudi Arabia will fold before Ecuador. Another factor that must be taken into account is how much money each OPEC country has in the bank, one measure of which is its foreign reserve holdings. How long could each country cover its annual budget deficits by drawing on its foreign reserves? Figure 6 shows the results for the $50/bbl scenario, which we can probably take as the “worst case”. Libya moves up to mid-pack and Venezuela, Nigeria and Ecuador are now the first to cry uncle (the foreign reserves data are from Wikipedia).

Duration Of Foreign Reserves @ $50

Figure 6 So what do we conclude from all this? I asked Euan Mearns for his opinions and he kindly offered the following insights:

All of the OPEC countries have money in the bank while all of the shale operators are reported to have large debts. This argues in favour of the OPEC countries being significantly fitter than the shale operators in the low price environment.

Nigeria and Venezuela seem most exposed to the downturn and will have to borrow within months to survive. I dare say that the wealthy Gulf States may help in order to maintain solidarity.

The UAE looks surprisingly vulnerable which points to the crisis being over within two years.

My opinion? No OPEC country is going to stop pumping because of economic constraints, nor is any OPEC country facing budget shortfalls – which is all of them except for Kuwait and Qatar – so no one is going to cut production in an attempt to drive up the oil price. A more likely eventuality is that growing economic woes will lead to insurrections in some OPEC countries, and here I agree with Euan that Venezuela and Nigeria are prime candidates. (Iran bears watching too.) But as we have seen from recent events in the Middle East, oil has a habit of continuing to flow come what may. So barring a major uptick in global demand it’s conceivable that low oil prices could be with us for some time.

By Roger Andrews

Source - http://euanmearns.com/  

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  • JB on December 12 2014 said:
    Roger I don't believe we are in for "long term" low oil prices, and while we may not see additional drillers in the shale, the operators already producing can, and probably would continue to produce even at a loss in the short term. Now determining the "short" term is different for various operators, but I don't see any of the efficient operators capping wells and selling off equipment. Even if we look at existing producers as if they were new business enterprises, we can argue that most if not all new business traditionally takes three years to turn a profit, so if we utilize that model/paradigm, current domestic shale producers could/would still produce for a three year time horizon. While we can't predict the term of low pricing, I'd bet everything I own that sub $60 bbl will not be with us for three years. This is fundamental economics of oligopoly markets.
  • Tim Bilsky on December 12 2014 said:
    Roger, you hit it dead on. The answer to the question lies in both economics and philosophical bent. "Social imperatives" = terroristic/communistic motives. The individuals controlling oil in non-industrialized nations are rich and care not about their fellow citizens. To a socialist, people are expendable, the product is not. As most American energy producers are about as non-socialist as possible, and want individuals in society to advance (they continue to increase their earnings this way), and the controllers of oil in most of the nations mentioned are despots, the OPEC leaders always have the upper hand. Not to mention, the government-mandated benefits that oil producers in the U.S. have to pay their workers, will always make it more expensive for American firms to do business.
  • GMR on December 12 2014 said:
    Interesting approach however suggest your analysis, while likely 'thumb suck' estimate based upon tightly controlled numbers(mis-information) from OPEC members on one side vs. publicly accessible US Shale company reports gives the enemy in this Oil War vital information to use against us as always.

    What you don't do is to project ahead to the point when OPEEC does finally reduce production to raise the price or the economic benefits of low cost of oil generate an increase in demand both of which will increase the price point where US Shale producers will quickly resume profitable production...

    So in the end who really wins...and at what cost for both sides?
  • r pettit on December 12 2014 said:
    Not sure if the fact that the 18 month backlog of wells that have already been bought and paid for are factored into this.
  • Steve on December 12 2014 said:
    Shale producers will have to "play well" with OPEC in a consolidated global oligopoly. This will raise prices through coordinated production levels (there will of course be cheating), but it is better to partner with your competitors than engage in price wars.

    Too much has been made out of the whole America VS OPEC thing. This is business & smart businessmen don't give a crap about American energy independence, They just want their share of the pie.
  • R. L. Hails Sr. P. E. (ret.) on December 12 2014 said:
    About 20% of the US economy is directly involved with oil and they will see lay offs, unemployment and corporate bankruptcy due to this drop in price. Those who were highly leveraged will go first and bottom feeders will buy up the fallen. But to 80% of the US economy, oil products are a cost, thus both private and corporate entities will be clearly enriched by this cost reduction, if they are diversified. The others who will be slaughtered are banks who funded the oil patch, speculators who were eternally long on oil prices, and environmentalists who push non carbon combustion technologies which could not compete at $100/b. I have read that new electronics and materials will push the US break even cost to the mid $40.

    Over seas it will weakened the hand of the OPEC debris (it has shattered) and Russia. Their monopoly, illegal in the US, has been broken. Russia will pipe their oil to China as a subservient supplier. (Europe can ignore Russia's threats if the US can ship oil to Europe)

    Fracking may rival the invention of the chip, or uranium fission as a historic game changer. If it remains peaceful, and does not destroy the climate, it will be a huge force to end global poverty.
  • J Ruth Florida on December 13 2014 said:
    The US will sanction Venezuela for human rights abuses and block its oil imports into the US in the near future if the lower price of OPEC petroleum begins to threaten the survivability of significant parts of American energy industries. That alone will prop up prices for US producers who will also move in quickly to up production to fill the void of the 750,000 BBD short fall that will be created. Venezuela of course will collpase into deeper barbaric violence and regime oppression as Marxist thugs desperately attempt to hold on to power.

    Moreover what you have failed to mention in your model is that US energy independence is a stated US national security goal and thus if the US domestic energy industry is threatened with serious economic damage by OPEC then the government will step in save it by simply either reducing or taxing imports from even more OPEC nations. If you do not believe it is possible we in fact already have a precedent of our government doing that very thing back during the Eisenhower Presidency and we will do it again. Moreover, friends I have in the US Congress and Senate are already discussing measures to deal with this very contingency through legislation which will be even more probable under the very non-green new Republican controlled house and senate. What OPEC will then do with an Extra 5 million BBD that it can no longer sell to the US will become their problem and will probably unseat monarchs and marxists. Do not be further amazed when Americans subsequently make a buck off the chaos selling weapons to factions causing further interruptions to OPEC oil production while leaving the US as the only stable source of supply. If you do not think that this is in the works....just wait!

    Finally, if you believe that Americans will allow islamic Kings and marxist thugs to wreck American enterprises in order to force Americans back to the parasitic OPEC trough, you are sadly mistaken and have not factored American social and political science into your model. The fact is that most Americans would be glad to pay a little more for gasoline at the pump so long as their money stays inside the US eploying and enriching other Americans rather than being used to fund undemocratic and American hating regimes in other countries....and that in the end is why the OPEC gamble will fail. JR
  • Seth on December 13 2014 said:
    "Why OPEC Will Win" is simply wishful thinking and the article comes days after it's clear that OPEC is dead, they have no control over pricing or production, and it's every man for himself. Most Shale oil is profitable at $42 per barrel, with some fields obviously higher, and some lower. This is from the IAE: "Most production in the Bakken formation, one of the main drivers of shale oil output, remains profitable at or below $42 a barrel, the IEA..."
    http://www.bloomberg.com/news/2014-11-27/oil-in-new-era-as-opec-refuses-to-yield-to-u-s-shale.html

    It's also clear that America's shale revolution, an iterative phenomenon that has occurred over decades, is resulting in cheaper, not more expensive" techniques to get more oil using "big data," more creative drilling, and other technological and process improvements.
  • Phillip on December 14 2014 said:
    Seth: What you are not realizing is the extremely perilous situation that most of the shale drillers are in because of their high levels of junk debt that they will have a very difficult time servicing.
  • Todd Monka on December 15 2014 said:
    PUT A $40.00 TO $50.00 IMPORT TAX ON EVERY OPEC BARREL OF OIL IMPORTED INTO THE UNITED STATES!!! OR AT LEAST THREATEN THAT IF THEY DON’T PLAY BALL WITH THE US.
  • Robert on December 15 2014 said:
    OPEC will not win. They are only going to cause a reset in the market. Contractors will renegotiate the cost of drilling wells, the US dollar is going to continue to increase causing an apparent drop in price and the oil companies that still have cash flow will continue to store their assets for futures when the price does go back up and buy out AFEs and real estate at bottom barrel prices. In reality this is going to be a good thing for the US both for the GDP as well as for domestic producers as the profit margins will be right on target once this is over. People also forget that Saudi Arabia has overstated their reserves by almost 40.0% and other OPEC countries are not happy with this nor is the "Big Bear" Russia. This is short lived. I see $40 barrels and maybe mid to high $30's but by 2nd quarter 2015 the prices will climb back up into the 70's.
  • Eimis on January 24 2016 said:
    As you see, OPEC did not win. Find some excuses now ;)

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