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Will The OPEC Deal Lead To A New Shale Boom?

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Is Saudi’s Market Share War Over, Is It On-Hold, or Is It Still Coming?

OPEC surprised the markets when word came out that for the first time in eight years the cartel planned to put oil production limits in place at its upcoming November meeting. Rumors have been zinging around the media for a little while, but yesterday’s announcement from OPEC sent oil markets upward to the tune of almost $3 per barrel. The rally continued on Thursday with WTI November contracts piercing $48 per barrel for a while in morning trading.

E&Ps were buoyed by the news, but a hundred oil and gas bankruptcies (and counting) serve as an ugly backdrop for recent predictions of continued record inventory levels and no market balance for another year—or two.

But that gloomy future gave way yesterday to a day of sunshine for the North American E&Ps, a generally optimistic group that has been too busy retooling their companies to smile much since OPEC last startled the global oil and gas sector by announcing its new strategy to chase market share rather than maintain price stability. That was on Thanksgiving Day of 2014. That took oil out of triple digits all the way down to the $20s–briefly. Oil producers have endured almost two years of being smacked around by post-crash market pricing.

But the projected changes that would be caused by such a move—representing an unprecedented agreement by arch-rivals Saudi Arabia and Iran—has analysts scratching their heads, sharpening their pencils, rebooting their commodities price models and spitting out research notes in a flurry of activity after delivery of yesterday’s OPEC news.

We noted the drop in U.S. oil inventories in recent weeks: OPEC

In its announcement, OPEC said the following:

“In the last two years, the global oil market has witnessed many challenges, originating mainly from the supply side. As a result, prices have more than halved, while volatility has increased. Oil-exporting countries’ and oil companies’ revenues have dramatically declined, putting strains on their fiscal position and hindering their economic growth. The oil industry faced deep cuts in investment and massive layoffs, leading to a potential risk that oil supply may not meet demand in the future, with a detrimental effect on security of supply. Related: Is The EIA Wrong On Texas Oil Production?

“The Conference took into account current market conditions and immediate prospects and concluded that it is not advisable to ignore the potential risk that the present stock overhang may continue to weigh negatively well into the future, with a worsening impact on producers, consumers and the industry.

(Click to enlarge)

“Based on the above observations and analysis, OPEC Member Countries have decided to conduct a serious and constructive dialogue with non-member producing countries, with the objective to stabilize the oil market and avoid the adverse impacts in the short- and medium-term.

“The Conference, following the overall assessment of the global oil demand and supply balance presented by the OPEC Secretariat, noted that world oil demand remains robust, while the prospects of future supplies are being negatively impacted by deep cuts in investments and massive layoffs. The Conference, in particular, addressed the challenge of drawing down the excess stock levels in the coming quarters, and noted the drop in United States oil inventories seen in recent weeks.

“The Conference opted for an OPEC-14 production target ranging between 32.5 and 33.0 mb/d, in order to accelerate the ongoing drawdown of the stock overhang and bring the rebalancing forward.”

In a conference call hosted by Paul Sankey and David Clark of Wolfe Research, the analysts examined what the surprise change in direction will mean to global oil prices and U.S. unconventional producers in particular, if OPEC follows through.

“What we are looking at here at the very least is a freeze,” Sankey said. “We were looking for more OPEC production growth but now we no longer think so.”

The analysts issued a research note yesterday that summed up the news like this:

“… little did we realise that not only would Saudi not cut to defend a weakening market but they would increase by 1Mbd by summer 2015. Why? To fight Iran for market share. Two years later, we again head towards a landmark Thanksgiving, this time with OPEC reverting to managing the market. Why? We believe the organization may be concerned about potential excessive under-supply by 2020. Maybe the Saudi IPO played a part. And simply, cartel economics, as we have repeatedly pointed out, have become compelling: 10 percent cut in volumes for 30 percent rise in price.”

During today’s call, Sankey and Clark said that a Saudi-Iran agreement “changes entirely what OPEC is doing.”

Sankey said he believes that the market is already in balance, based on EIA data, OECD data and other analysis. “Let’s call it a balanced market we’re in now. So every barrel they cut gets toward an undersupplied market. 32.5 -33 MMBOPD is the suggested range OPEC will move to. The cut would be 700,000 BOPD. Remember that is every day,” Sankey said. “If you go from a balanced market to a 700,000-barrel undersupplied market, that is a big deal.” Related: Has Saudi Arabia Pushed OPEC Too Far?

“The key question is ‘will Iran respect the deal?’. In general Saudi has done what they said, followed by UAE, Kuwait and others. … [But,] if these guys don’t trust each other then it’s a different story if there is a race to more production.”

Why did OPEC do it?

“With weaker demand predicted through 2017 they could see a rough market coming,” the analyst theorized. “Being a cartel the economics were overpowering: a 10 percent cut could give as much as a 30 percent rise in oil prices.

“The thesis is that marginal supply growth comes in the future from U.S. unconventional [production]. “This is extremely bullish for all the U.S. E&Ps on the unconventional side,” Sankey said.

“U.S. production growth hit 1.3 MMBOPD in Dec. 2014. Today the capacity limits are geology, infrastructure, and water handling. Let’s say they can get back to 1.3, 1.4 MMBOPD by 2020, we could hit that place in the market a year earlier or more. In the scenario with OPEC capped at 33 MMBOPD, that wipes out the overhang by 2017.”

A call participant asked the question, “Do you think there is an implicit price they’re trying to target? What price do you think the Saudis want?”

The Wolfe analysts said, “I think they want demand growth and not too much supply growth. Saudi Arabia believed that the marginal breakeven price in the U.S. is $80 per barrel. But [ExxonMobil CEO Rex] Tillerson talked about how good the U.S. E&P guys are, especially when their backs are against the wall.”

“It goes to $51 per barrel at the margin. We think there will be acceleration [of activity] above $50. I would say if we were in a $60 + environment that would be a good price – without destroying demand. I don’t think we could sustain prices as high as they were in the past, but $60-$80 I would think [OPEC] would be very happy with.”

Q: What outcome do you expect from the November OPEC meeting? Are we going to get specific quotas?”

“A camel is a horse designed by a committee,” Sankey said, referring to the punchline from an old joke. “OPEC has appointed a committee to work this out. Seems they’ll exclude Libya and Nigeria. Iran will stick at 3.7 [MMBOPD] because they are just back in the markets post sanctions…. The details are extremely unclear and some of this was from the original Algerian proposal. The fact that Saudi and Iran are remotely agreeing is the headline.”

By Oil & Gas 360

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