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).
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