How the US fracked OPEC: Oil enters new era

Lasting change: The OPEC has thrown in the towel, leaving it to the market itself to control supply, analysts say.

 Photo: Erin Jonasson

Lasting change: The OPEC has thrown in the towel, leaving it to the market itself to control supply, analysts say. OPEC's decision to cede no ground to rival producers underscored the price war in the crude market and the challenge to US shale drillers. The 12-nation group abandoned its role as a swing producer, ignoring the steepest slump in oil prices since the global recession to keep its output target unchanged.

"We are entering a new era for oil prices, where the market itself will manage supply, no longer Saudi Arabia and OPEC," said Mike Wittner, the head of oil research at Societe Generale in New York.

"It's huge. This is a signal that they're throwing in the towel. The markets have changed for many years to come."

The fracking boom has driven US output to the highest in three decades, contributing to a global surplus that Venezuela has estimated at 2 million barrels a day.

That's equal to or more than the production of six OPEC members.

Demand for the group's crude will fall every year until 2017 as US supply expands, eroding its share of the global market to the lowest in more than a quarter century, according to the group's own estimates.

Benchmark Brent crude fell by the most in more than three years after the OPEC decision.

Futures for January settlement fell 6.7 per cent to $US72.58 in London late Thursday after trading as low as $US71.25. Prices peaked this year at $US115.71 in June.                          

Market Signals

"We will produce 30 million barrels a day for the next 6 months, and we will watch to see how the market behaves," OPEC Secretary-General Abdalla El-Badri told reporters in Vienna after the meeting.

"We are not sending any signals to anybody, we just try to have a fair price."      

Conventional oil producers in OPEC can no longer dictate prices, United Arab Emirates Energy Minister Suhail Al-Mazrouei said in an interview in Vienna this week.

Newcomers to the market who have the highest costs and created the glut should be the ones to determine the price, he said.    

 "That is what OPEC is hoping for," said Carsten Fritsch, a commodity analyst at Commerzbank in Frankfurt. "It's the question of who will blink first."      

OPEC will feel pressure too, with prices now below the level needed by nine member states to balance their budgets.    

OPEC Weakness      

"They haven't taken collective action," said Richard Mallinson, an oil analyst at London-based Energy Aspects. "That doesn't mean they won't do it in the next few months if prices stay low."      

Venezuela's oil income has fallen by 35 per cent, President Nicolas Maduro said on state television this month.

Yields on the nation's benchmark bonds due in 2027 reached a six-year high this month, while foreign-currency reserves are close to an 11-year low.      

Nigeria increased interest rates for the first time in three years this week and devalued its currency. The government is planning to cut spending by 6 per cent next year, according to Finance Minister Ngozi Okonjo-Iweala.

Shale Crash      

US oil production rose to 9.077 million barrels a day last week, the highest level in weekly data from the Energy Information Administration going back to 1983.

Output will grow to 9.4 million next year, the most since 1972, it forecasts.      

The boom has been driven by a combination of horizontal drilling and hydraulic fracturing which has unlocked supplies from shale formations including the Bakken in North Dakota and the Eagle Ford in Texas.

The technique is typically more expensive than pumping from conventional reservoirs.      

Middle Eastern exporters including Saudi Arabia, Iran and Iraq can break even at about $US30 a barrel, Sanford C. Bernstein & Co. said in a report last month.

Some US. producers need more than $US80 and output growth will start to slow with prices below that level, it said.

OPEC's policy will spur a crash in the US shale industry, Leonid Fedun, vice president and board member at Lukoil, Russia's second-largest oil producer, predicted in an interview before the group's decision.      

"In 2016, when OPEC completes this objective of cleaning up the American marginal market, the oil price will start growing again," said Fedun. "The shale boom is on a par with the dot-com boom. The strong players will remain, the weak ones will vanish."  

'Over to you, America'

Ministers from Russia, Mexico, Venezuela and Saudi Arabia met in Vienna on Tuesday.

The meeting was the result of weeks of diplomacy by Venezuelan Foreign Minister Rafael Ramirez, who was attempting to coordinate with producers outside OPEC to halt the collapse in oil prices. 

Yet they failed to reach an output accord.      

Igor Sechin, the boss of Russia's largest oil producer Rosneft, said after the meeting that his nation wouldn't need to cut output even below $US60.      

"The question is, what price level will be low enough to slow US production growth?" said Torbjoern Kjus, an analyst at Norwegian bank DNB. "What price will get US growth to slow to 500,000 barrels a day from this year's rate of 1.4 million barrels?"      

Only about 4 per cent of US shale production needs $US80 or more to be profitable, the Paris-based International Energy Agency says.

Most production in the Bakken formation, one of the main drivers of shale oil output, remains profitable at or below $US42 a barrel, it estimates.

The agency expects US supply to grow by almost 1 million barrels a day next year, with increasing flows to international markets.     

"OPEC's decision means it is over to you, America," concludes Miswin Mahesh, a London-based commodities analyst at Barclays.

"This opens the window for the US to be the new swing producer."

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Showing 11 reactions

commented 2014-12-03 14:58:18 -0500 · Flag
A.A. writes:

@delroi: Your figures are interesting and accurate in pointing out that the Saudis can probably keep pumping even if the price of oil went to $5 per barrel…they have the cash reserves to wait out any competition. Where I slightly veer from your assessment is that I think that the Saudis have the U.S. oil industry as much in their sights as Iran and Russia as a competitor to destroy economically…and perhaps they fear U.S. energy even more than those 2 miscreant regimes…because when the U.S. no longer needs the Saudis they are then exposed to existential dangers…
commented 2014-12-02 15:41:38 -0500 · Flag
Delroi writes:

Alas, this is not correct.

First of all, it’s important to distinguish between a crude price required for operational break-even and one required for fiscal break-even (i.e. price required to balance over-all government budgets). The price required for the latter is obviously higher than that required for the former, which is chiefly why these nations will continue to pump/operate for a fairly long time after the marginal price of crude/barrel has fallen below a ‘national deficit’ threshold.
Fiscal (government budget) break-even crude oil prices as of 11/27/14:
  • Libya – $184/barrel
  • iran — $130
  • Algeria — $130
  • Nigeria — $123
  • venezuela — $118
  • Saudi Arabia — $106
  • Iraq — $101
  • Russia — $100
  • oman — $100
  • UAE — $77
  • Qatar — $60
  • Kuwait — $54


Brent crude 12/2/14 — ~$71/barrel


So it seems the vast majority if US shale projects aren’t yet menaced by sub-break even pricing, but the problem is that most of it was financed on monstrous leverage, whose market prices are now breaking down and adding another element to the risk equation for US shale operators.

The price crash seems to be the US working in conjunction with Saudi Arabia, using the ‘oil weapon’, in an attempt to break Russia/ISIS/Iran. The saudis are doing it despite the ~$30/barrel deficit between its fiscal break-even and the current market price of crude because it has huge ($800bn+) reserves to deploy as a medium/long-term cushion.

The Russians have been the 3rd-largest buyer of gold in the last few years, among other reasons, in order to back-stop their currency against this type of asymmetrical economic war, moreover, they’re signing huge petro-deals with china (>surprise
commented 2014-12-02 02:39:02 -0500 · Flag
A.A. writes:

Only a small percentage of U.S. oil / gas Fracking enterprises are affected until it hits 45-50$…then it gets dire. The Saudis can pump profitably below $40…the U.S. cannot. They will do their best to wipe the Americans out…
commented 2014-12-02 02:35:33 -0500 · Flag
Miller writes:

Suffering will begin in earnest with 60 dollar oil….
commented 2014-11-30 18:15:06 -0500 · Flag
V.M. writes:

Hey as someone who lives in Idaho I want nothing to do with russia!!
commented 2014-11-30 18:14:41 -0500 · Flag
A.A. writes:

Russia and its “citizens” (subjects) live in their “own private Idaho”…a delusional state of self-mythologizing, geopolitical ignorance, and puffed-up bluster. They are a demographically-doomed kleptocratically-governed gas-pump masquerading as a “superpower”. The sanctions are not hurting them because “Russians don’t mind suffering”? Good. LET THEM SUFFER IN PRIDEFUL MISERY. When their Ruble is worth less than toilet paper and their oil and gas industries are marginalized by the new energy revolution (fracking, renewables, U.S. becoming the world’s biggest energy producer) we will see how much they love their little swaggering despot and his conga-line of thieving oligarchs.
commented 2014-11-30 18:13:51 -0500 · Flag
John C writes:

food for thought: light at end of tunnel can get brighter as
innovations in fracking improve & EU sees the light & frees itself
from Russian gas. A big “if” no doubt

The boom in U.S. shale gas has left gas-exporting countries shopping
for other customers. Europe, as it adds terminals to handle liquefied
natural gas, will be able to offset its own declining production with
supplies from countries such as Qatar. Norway’s Statoil sells more gas
to other European nations than Russia’s Gazprom.
commented 2014-11-30 18:12:55 -0500 · Flag
Spartacus writes:

2 take-always: These collapsing prices are definitely putting the squeeze on the Russia petro economy,
‘ … but Russians don’t mind suffering. They’ve successfully endured it for centuries’
but we are approaching the Winter heating season, and Russian Nat. Gas is the ONLY game in town for the Europeans,

2nd, the ridiculously cheap Gas (benzene) prices that I discovered yesterday at the filling station are the ONLY thing keeping brother Barry alive, Americans are a sloppy lot, give them cheap Gas for their urban land barges and they immediately retreat to a catatonic state of mindless satiation.
commented 2014-11-30 18:10:46 -0500 · Flag
Brad writes:

You make a strong case for the Russian viewpoint. If your description is accurate, the Western sanctions aren’t just ineffective. They are actually counterproductive, giving Putin’s people more reasons to support him.
commented 2014-11-30 17:58:15 -0500 · Flag
Bella K. writes:

I correspond from time to time with an old classmate who lives in Russia. This is a well-educated and well-informed person, a hardcore Russian patriot. This person is typical of the 80% or more of the Russian population who eagerly and wholeheartedly support Putin and his policies.
This correspondence gives me an impression that they WORSHIP Putin. They perceive not Russia, but the USA as an aggressor. Their views of the Ukrainian conflict are directly opposite of our views here — and I am not talking about Putin and his cohort, but ordinary Russians.
Russians consider the sanctions very unfair, yet they take it as a challenge, a competition they’re determined to win. They are WILLING to accept great sacrifices — whatever it takes! — to defend their national pride and not submit to Western pressure.
These people just came out of near-starvation in the 1990s; they’re not strangers to extreme frugality. Indeed, Russian history shows that Putin’s plan to rebuild their economy is realistic. They did it during WWII. They have all the resources internally.
This is Putin’s chance to ask people to accept sacrifices — and they will! — in order to rebuild and diversify their economy IN SPITE of the sanctions. The people have clear goals (conveyed to them by Putin), motivation and determination to achieve those goals.
Putin already improved their living standards, so they trust him. In light of the sanctions, the spirit of mobilization is not unlike that of the WWII period in the USA.
For all these reasons, I do not believe Putin is bluffing. He knows what kind of people he is leading and what resources are at his disposal. They’re all survivors.
On the other hand — a bit more objectively — they still do have a kind of a demographic crisis. Much of the male population in places like Siberia are heavily addicted alcoholics who die in their early to mid- 40s. Putin might have difficulties with necessary human resources. But even this can improve with intensive government stimuli and support of increased birth rates, etc.
As repugnant as it might sound to the Western ear, Putin has made all the right moves for himself, and some for Russia. So far, he is succeeding. His new economic revitalization plan could actually work.
commented 2014-11-30 17:53:41 -0500 · Flag
Ben writes:

The sanctions are having the opposite effect from what is intended. The effect of significantly lower crude prices will most certainly affect Russia if they remain for any extended period. Western economic sanctions are clearly having an impact on Russia, as are tumbling oil prices. The Obama administration apparently thinks the Russian people will rise up and demand change if we just create enough suffering for them.
The problem with this theory is that Russians don’t mind suffering. They’ve successfully endured it for centuries. They wear it as a badge of pride, so another year or two is no big deal to them.