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Global Risk Insights

Global Risk Insights

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Price War: OPEC Versus U.S Shale Likely To Continue Despite Iran Deal

Price War: OPEC Versus U.S Shale Likely To Continue Despite Iran Deal

Regardless of the final outcome of Iran’s nuclear program negotiations, the coming months will see a continuing price war between OPEC producers and the shrinking US shale sector.

The recent agreement on Iran’s nuclear program exacerbated fears that the price of oil will continue to slide downwards once Iran’s vast oil reserves start to flow onto the global markets without restriction. However, there are signs that the process will at best be a gradual one, and that it will not dramatically affect the price of oil in the short term.

The immediate announcement of the deal last April 2nd brought a 5% cut in the price of Brent benchmark. However, the price quickly bounced back to around $60 per barrel. Related: Huge 100 Billion Barrel Oil Discovery Near London

A comprehensive deal, meant to be reached by June, is still far away, with many obstacles still present between the international community and Iran. In addition, much will depend on reactions from the U.S. Congress, where the Republican majority will most certainly try to boycott the final agreement.

It is highly unlikely that Iran will be allowed to start exporting its oil freely before June, and even if this happens, it will take at least six months or more before a full capacity production and export chain is re-established.

The swing in oil prices is likely to come from a different side.

Ever since OPEC decided not to cut its production quotas in November 2014, U.S. shale producers have been struggling to cope with low oil prices, and there are growing signs that this is finally taking its toll. Related: Resource Dependence Could Prove Fatal For Canadian Economy

The key reason for this lies both in high production costs that in many cases significantly outpace current oil prices, and in U.S. producers’ increasing difficulty to raise money to continue with the investment cycle. Shale oil is a highly demanding industry in terms of capital investment, and it requires a constant influx of money to sustain its activities.

During the period of “easy money” supported by the Federal Reserve’s quantitative easing (QE) policy and high oil prices, investing in U.S. oil and gas sounded like good advice. However, it seems that with prices below $60 per barrel, this argument is not entirely valid.

Since 2012, the U.S. shale revolution was driven not only by high oil prices, but also by high-yield junk bonds issued by many smaller shale companies. As the low oil prices slash the value of their oil and gas reserves, and as the yields on their bonds have almost doubled, many smaller producers will struggle to keep their heads above the water.

According to JP Morgan’s forecast, up to 40% of U.S. energy companies that issued junk bonds could default by 2017 if the period of low prices continues. Barclay’s estimates show that the total debt of the U.S. exploration and production companies makes up to 17% of America’s junk bonds market.

This does not necessarily need to be a bad thing. Related: Who Will Control The World’s Water: Governments Or Corporations?

The Saudi strategy to “kill” the U.S. shale sector with low prices will most certainly have a strong impact, and in the long term will probably stabilize oil prices at around $70-80 per barrel. At the same time, it will make the U.S. oil sector more consolidated and resilient to price fluctuations, with technology innovations and processes that will drive production costs down and help to make the industry a sustainable part of the global energy market.

In the meantime, U.S. oil production is still rising. According to Rystadt Energy consultancy, U.S. annual oil production is on track to reach an all time high of 9.7 million barrels per day by September, surpassing the 1970 record of 9.64 million barrels per day.

This also suggests that the oil price war between OPEC and U.S. producers could last longer than initially expected, with oil prices remaining at levels of around $55 per barrel or lower for the rest of 2015, and potentially well into 2016.

By Ante Batovic for GlobalRiskInsights

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