As Dan Dicker is away this week, please find below a guest piece provided by our new Managing Editor Chris Dalby.
In the final hours, as delegates were locked in backrooms, the chatter coming out of Vienna hotels concerning a potential production cut from OPEC warned of the worst. Despite attempts by Angola and UAE to reassure the markets, Saudi Arabia stuck to its guns regarding a possible cut to production. Attempts by Algeria and Venezuela to secure a 2 million barrel a day cut were steamrolled while negotiations with Russia and Mexico to share the pain of production cuts failed. Moscow has sought to explain away its refusal in various ways, pointing to Siberian wells that are difficult to turn off during the winter, or explaining that the low ruble has not made a large dent in the ruble value of oil exports. However, the simple truth is that Russia cannot afford to produce less and needs to sell at $100 a barrel. But ultimately, so stubborn was Saudi Arabia in barring a cut, Russia’s decision may not have been a major factor.
OPEC has mismanaged this from the start. Even if it had decided to cut its current quotas by up to 2 million barrels a day, the mixed signals from OPEC’s famously disparate membership would have wreaked panic on the markets.
There is a good reason that Venezuela was playing the ‘good cop’ at OPEC, with its Foreign Minister Rafael Ramirez desperately trying to cobble together an agreement. The government revenues of nations like Venezuela, Iran and Algeria are simply too dependent on oil for them to comfortably swallow a further oil price drop. But all this pales in comparison to the influence wielded by Saudi Arabia. Long the OPEC kingmaker, Saudi Arabia is seeing a different energy landscape, one where the U.S. will soon lift its ban on oil exports. Riyadh is desperate to secure its market share and has actually boosted its output in recent months. Now that it has unilaterally blocked a production cut, the real question becomes how low will Saudi Arabia allow prices to go?
On Wednesday, WTI was trading at $73.42, its lowest point in over four years, and this will continue during the week if a deal is not made. On Thursday, this tumbled to below $70, while Brent fell by over six dollars to below $72. The response from Saudi Oil Minister Ali al-Naimi was a wry smile and a declaration that OPEC made “a great decision.”
This may be playing right into Saudi hands, as Société Générale believes that Saudi Arabia may well be hoping for a further $10 drop to below $65, with that level being needed to make the U.S. nervous. A report by the French bank estimates the break-even costs for Eagle Ford, Bakken, and Permian all stand at around $65. While a short-term drop in U.S. production would benefit OPEC when prices rise again, such a gamble would be a very unwise move, given the markets’ confidence in the long-term viability of U.S. shale. And that confidence is deserved.
With estimates for shale oil production now rising up to 12 million barrels a day (in the most optimistic eyes) by 2020, the U.S. is not in a position where it will feel threatened. Even cuts of 1 million barrels a day would not make a dent. MarketWatch estimates the U.S. supply of oil has risen up to 25% over 2005 levels, while domestic demand has only risen 15%. Given this disparity, any attempts by OPEC to keep oil prices artificially low to put a hurt on American oil will only further incentivize Congress to lift the ban on oil exports.
In the short-term, the refusal to cut production will hurt everyone, even the U.S., which might see short-term investment prospects in its shale gas fields dwindle. But Russia, which is seeing losses of up to $100 billion a year due to tanking oil prices, and the likes of Venezuela and Nigeria cannot accept low prices for long. But while Saudi Arabia has not spoken of a floor for oil prices it would be prepared to accept, it is already being outflanked by other OPEC members entering damage control. Iraq’s oil minister has stated he believes a floor would be set at $65-70
Ultimately, this may expose OPEC for what it is becoming: a contrarian cartel which is rapidly losing power, with many of its members pumping at full capacity, and whose dominance of global oil markets is fading fast. Even if US production capacity takes a hit for a short time, the balance of power has changed. The world was watching the OPEC summit in Vienna this week. Riyadh better pray that is still the case next time.