Oil seen in new era as Opec won’t yield to US shale boom

A general view of the Opec building and logo in Vienna. The group’s decision on Thursday to keep output target unchanged propelled futures to the lowest since 2010, a level that means some shale projects may lose money.

Bloomberg

Dubai/Manama

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 Organisation of Petroleum Exporting Countries kept its output target unchanged even after the steepest slump in oil prices since the global recession, prompting speculation it has abandoned its role as a swing producer. Thursday’s decision in Vienna propelled futures to the lowest since 2010, a level that means some shale projects may lose money.

“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 SA 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 2mn bpd, more than the production of five 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 the most in more than three years after Opec’s decision, sliding 6.7% to close at $72.58 a barrel. Futures for January settlement sank to $70.15 on Friday, the lowest close since May 2010. Prices peaked this year at $115.71 in June.

“We will produce 30mn 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.”

Opec pumped 30.56mn bpd in November and has exceeded its current output ceiling in all but four of the 34 months since it was implemented, according to data compiled by Bloomberg. Opec’s own analysts estimate production was 30.25mn in October, according to a report on November 12. Members will abide by the 30mn barrel-a-day target, El-Badri said on Friday.

“Opec has chosen to abdicate its role as a swing producer, leaving it to the market to decide what the oil price should be,” Harry Tchilinguirian, head of commodity markets at BNP Paribas SA in London, said on Thursday by phone. “It wouldn’t be surprising if Brent starts testing $70.”

Conventional oil producers in Opec can no longer dictate prices, UAE Energy Minister Suhail al-Mazrouei said in an interview in Vienna on November 26. 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,” Carsten Fritsch, a commodity analyst at Commerzbank AG in Frankfurt, said in an e- mail. “It’s the question of who will blink first.”

Opec may now be prepared to let prices fall to force some drillers with higher production costs to stop pumping, said Julian Lee, an oil strategist who writes for Bloomberg First Word and has worked in the industry for 25 years. That scenario would mark the start of a fourth oil-market era since the end of the 1970s, he said.

Since the early 2000s, surging demand growth drove up prices allowing companies to apply new extraction techniques and develop deep-water and other costly oil. That ended an era that pervaded since the mid 1980s, which was characterised by low prices and Opec regaining the market share that it had previously sacrificed in an attempt to preserve high prices, Lee said.

Opec will face pressure too, with prices now below the level needed by nine member states to balance their budgets, according to data compiled by Bloomberg.

“They haven’t taken collective action,” Richard Mallinson, an oil analyst at London-based Energy Aspects Ltd, said by phone. “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%, President Nicolas Maduro said on state television on November 19. Nigeria increased interest rates for the first time in three years on November 26 and devalued its currency. The government is planning to cut spending by 6% next year, Finance Minister Ngozi Okonjo-Iweala said on November 16.

US oil production has risen to 9.077mn bpd, the highest level in weekly data from the Energy Information Administration going back to 1983. Output will climb to 9.4mn next year, the most since 1972, it forecasts.

Middle Eastern exporters including Saudi Arabia, Iran and Iraq can break even on a cost basis at about $30 a barrel, Sanford C Bernstein & Co. They need more to balance their budgets. Some US producers need more than $80, the consulting firm said in a report last month.

Opec’s policy will spur a crash in the US shale industry, Leonid Fedun, a vice president and board member at OAO Lukoil, Russia’s second-largest oil producer, said in an interview in London 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.”

Igor Sechin, the chief executive officer of Rosneft, Russia’s largest oil producer, said after a meeting with Venezuela, Saudi Arabia and Mexico that his nation wouldn’t need to cut output even if prices fell below $60.

“The question is, what price level will be low enough to slow US production growth?” Torbjoern Kjus, an analyst at DNB ASA, Norway’s biggest bank, said by phone. “What price will get US growth to slow to 500,000 bpd from this year’s rate of 1.4mn barrels?”

Only about 4% of US shale production needs $80 or more to be profitable, according to the Paris-based International Energy Agency. Most production in the Bakken formation, one of the main drivers of shale oil output, remains profitable at or below $42 a barrel, the IEA estimates. The agency expects US supply to rise by almost 1mn bpd next year, with increasing flows to international markets.

“Opec’s decision means it is over to you America,” Miswin Mahesh, a London-based commodities analyst at Barclays, said in an e-mail. “This opens the window for the US to be the new swing producer.”