by Frank Umbach
In the era of conventional oil, countries made decisions based on prices above $100 per barrel. The Organization of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia, essentially set the global oil price. Now, it is shale oil production in the United States that determines prices. Diverging geopolitical interests among OPEC’s members have eroded trust within the organization. This lack of trust makes it more difficult to enforce collective decisions that would be mutually beneficial. However, even if OPEC manages to freeze or cut production, the impact on the oil price will likely be limited, unless major non-OPEC producers such as Russia and the U.S. get on board. Moscow has voiced a willingness to join in such an action, but could renege at any time.
Since the 1970s, OPEC had been the most influential actor in the oil market. Its production held relatively stable, and the organization limited its spare capacity to balance supply and demand. Before 2014, OPEC controlled more than 40 percent of the world’s oil output – much less than the nearly 50 percent share of its heyday in the mid-1970s.Two years later, its market share is even lower. From early summer 2014 to January 2016, the oil price sank from $107 to just $27 per barrel. At the time, it was forecast that prices would climb back to $60-70 per barrel by the end of 2016. But by November, they were still under $50 per barrel.
The likelihood of prices rising much higher than $60 per barrel has not improved over the past year. While OPEC coordinates the oil policies of its member states to ensure steady income and a stable market, Saudi Arabia has always been the dominant producer and has had the most influence. However, the Saudis have waged a price war since 2014 with the goal of forcing U.S. shale oil production to collapse. That effort has largely failed.
Upcoming meeting
In the old oil era, Saudi Arabia was not just the world’s biggest producer and largest exporter (with 15 percent of the global market). It also held the largest spare capacity – considered the “nuclear weapon” of the global oil market. This gave Riyadh unrivaled influence. But its ability to act unilaterally within OPEC undermined the organization’s role as a price setter. Since 2014, the Saudis have been less willing to have OPEC maintain that role for both economic and geopolitical reasons. The U.S has reduced its engagement in the Middle East and Saudi Arabia faces the prospect of a rising regional rival in Iran. Riyadh has no interest in seeing Tehran gain economic sway through rising oil revenues.
In 2017, non-OPEC oil production is expected to grow by at least 200,000 barrels per day from 2016 levels. After informal talks in Algiers in September, OPEC announced that it would work out a plan to cut output between 250,000-750,000 barrels (just 1-2 percent, to about 32.5-33 Mb/d) ahead of its next ministerial meeting on November 30. There was no agreement on how to split the cut between members.

OPEC members were split on the topic of whether to cut production at the September 2016 informal meeting in Algiers (source: macpixxel for GIS)
While low oil prices benefit consumers and importing nations, they hurt high-cost producer countries – in particular, those whose budgets are highly dependent on oil exports. Even Saudi Arabia ran a budget deficit of $98 billion in 2015 (16 percent of its GDP), with a deficit of $87 billion projected for 2016. Riyadh has cut government salaries by 20 percent and reduced public spending.
In the short term, OPEC faces a dual challenge. The first is U.S. shale oil output and the second is a substantial production increase in Iran, Iraq and elsewhere.
U.S. shale
In the old oil era, emerging markets such as China drove ever-rising demand. Conventional oil production increased with new investments in ultra-deep offshore fields (such as Brazil’s sub-salt fields), remote areas (the Arctic, Siberia) and Canada’s oil sands – all high-cost production options. But between 2010-2015, combined conventional and unconventional U.S. oil production nearly doubled from slightly more than 5 Mb/d to 9.4 Mb/d at a cost of between $40 and $80 per barrel. In 2015, 52 percent (4.89 Mb/d) of total U.S. crude oil production came from shale (tight) oil – equal to almost half of Saudi Arabia’s production. Due to low oil prices, the number of oil rigs in the U.S. has dropped by 80 percent and oil production has decreased to 8.5 Mb/d. More than 100 companies have gone bankrupt and some 120,000 jobs have been lost since the beginning of 2015.
However, U.S. shale production has slowed far less than expected because of increased efficiency, operational cost cuts and improving technology. Average production costs have fallen by 30 to 40 percent for U.S. shale wells, compared with just 10 to 12 percent elsewhere. About 60 percent of U.S. shale oil output is now considered commercially viable at $60 per barrel; only 20 percent of conventional deep water oil production is. The shale oil industry has proven much more flexible due to its short drilling cycle – it does not require large upfront investments to recover quickly when prices rise. By the end of 2017, production levels may increase by 600,000 to 700,000 barrels per day. Investors are already interested in new opportunities of shale oil projects.

U.S. oil producers have increased efficiency. About 60 percent of American shale oil output is now considered commercially viable at $60 per barrel (source: macpixxel for GIS)
Shale oil production may even jump from 4.5 Mb/d in 2015 to 8.5 Mb/d by the mid-2020s. New deposits from which it should be cheaper to extract oil have been discovered. A case in point is the Permian Basin in Texas, where average breakeven prices range between $35 and $40 per barrel – in some fields it may even fall below $30. Most of the 150 new rigs in the U.S. have been installed there. The Permian Basin is home to the largest number of drilled but uncompleted wells in the U.S. – 1,348 as of August 2016. This will become a large source of production as oil prices rise. In the coming years, waterless fracking, laser drilling and other new technologies will make shale oil extraction safer, cleaner, leaner and more competitive.
A new study by Rystad Energy confirmed the U.S.’s strengthening position in the global oil market. It concluded that, for the first time in history, the U.S. holds more recoverable oil reserves (264 billion barrels) than both Saudi Arabia (212 billion barrels) and Russia (256 billion barrels). More than half of U.S. oil reserves are shale oil, compared with 30 percent globally. If President-elect Donald Trumpfulfills campaign promises to lower taxes and ease environmental regulations, the U.S. shale oil and gas industries will get a further boost.
Iran and Iraq
A weakening of OPEC may help emerging oil powers Iran and Iraq raise production and expand market share. Iran is OPEC’s third largest producer, holding 9.3 percent of global oil reserves. At the September meeting, Tehran rejected calls for it to reduce output along with other OPEC members. Iran is currently pumping out 3.6 Mb/d and is unwilling to freeze output until it regains the production levels (4 Mb/d to 4.2 Mb/d) and market share in OPEC (13 percent) it had before the West imposed sanctions. It even aims to increase production to 5 Mb/d within three years. Iran is in a better position to keep output high and endure low prices than other OPEC members – oil revenues account for a much smaller share of its state budget.
Iraq, OPEC’s second-largest producer, is also looking to increase production. It has been exempt from past OPEC quotas due to its recent history of war and sanctions. But its output over the last two years has grown from 3.2 Mb/d to 4.35 Mb/d in 2016. It plans to expand production to 6 Mb/d by 2020 and wants to reach to 7 Mb/d thereafter.
In addition, production levels of Libya and Nigeria were up for negotiation after OPEC’s Algiers meeting. Both countries have seen output and market share drop due to domestic violence. In particular, Nigeria’s oil production could see a big rise if it manages to regain stability. Its production declined to just 1.27 Mb/d at the end of 2015 after averaging 1.8 Mb/d throughout the previous year.
OPEC rising
OPEC could regain its heft in global markets if the following developments play out:
• In 2015, global investment in the energy sector fell 8 percent, with the upstream oil and gas sector seeing the biggest decline in its history. The oil majors have shelved new high-cost projects worth some $400 billion. The collapse in investment has already resulted in a dramatic decline in the discovery of new oil fields. This state of affairs could trigger a global supply shortage and unpredictable price spikes if demand for oil rises sharply. The security of global oil supply could even be threatened, leading to new geopolitical rivalries.
• Spare capacity globally has significantly decreased, meaning unrest in Libya, Iraq, Nigeria or Venezuela could easily disrupt oil supplies enough to cause a shortage. Even Saudi Arabia’s spare capacity is limited. Even as the “global central bank of oil,” it can only increase production from its current 11.5 Mb/d to 12.5 Mb/d.
• A scenario where oil prices remain low for an extended period could leave high-cost oil fields stranded and push some countries out of the market. This would fuel domestic instability in those states, but could also make the world more dependent on the few low-cost producers in the Middle East. In this scenario, the security of global oil supply would be less diversified, more insecure and less resilient against unanticipated disruptions.
However, oil stocks have accumulated over the past two years and now stand at a record level of 3.09 billion barrels. This reserve could function as a substitute for limited spare capacity, at least in the short term. The more realistic scenario is that OPEC will become marginalized.
Diminishing influence
Many OPEC countries are not low-cost producers and member states’ interests are becoming increasingly divergent. This has made it more difficult for the organization to agree on new production limits. From this perspective, an effective freeze or cut in production seems difficult to achieve and even more unsustainable in the long run. OPEC’s history has shown that members often do not adhere to agreements to freeze production.
Most experts do not expect oil prices to rise above $60 through 2017, and instead predict that a price floor of $40 and $60 will emerge. The new, skeptical forecasts stem from additional supply coming onto the markets. This includes more U.S. shale oil, higher output from Norway and the long-delayed restart of production from the giant Kashagan field in Kazakhstan, which is expected to yield up to 230,000 barrels per day by the end of this year and 370,000 barrels in 2017. Even considering predictions that output from currently operational oil fields could decrease by 4.2 percent, new projects could add another 2.7 Mb/d of net supply to the already glutted global oil market. The International Energy Agency (IEA) downgraded its latest forecast for demand growth in 2017 by 100,000 barrels per day, to 1.2 Mb/d. The change was largely the result of China’s economic slowdown, which is expected to continue.
Russia’s oil fields will begin to run dry soon. Since it has been unable to expand production beyond its present, post-Soviet record high of 11.1 Mb/d, Russia has expressed its willingness to support an OPEC production freeze. It needs an oil price of $65-75 per barrel for its operations to be profitable. However, Moscow has so far committed to nothing specific and its “support” might prove short-lived: an oil price above $60 would stimulate a rapid increase in U.S. tight oil production, which is already recovering and expected to expand again next year. That would add more oil to the global market, pushing prices back down below $40 per barrel.
Any deeper or longer lasting production cut from OPEC could ultimately prove self-defeating. Reaching a price level high enough to generate financial relief for its members but low enough to keep high-cost producers from reentering the market demands sophisticated micromanagement of global oil prices. This seems impossible, particularly considering that OPEC and non-OPEC producers have not been able to agree on a production cut in 15 years.
In the long-term view, Saudi Arabia appears to have lost trust in its oil reserves as the best instrument to preserve economic stability and regional influence. This is a consequence of climate protection policies worldwide, technological advances in the energy sector, the increasing use of renewables and the rising popularity of electric and hybrid vehicles. The transport sector still depends on oil and gasoline for 90 percent of its fuel and accounts for 55 percent of total oil use worldwide. But the transition from fossil fuels to a low-carbon economy could take place faster than the oil and gas industry expects. The kingdom’s influential Deputy Crown Prince Mohammed bin Salman has already announced a “Vision 2030” plan that aims to boost the country’s non-oil revenues, which currently only stand at 10 percent of the total.
Related Articles:
Source: Geopolitical Intelligence Service
![GIS 2 GIS_[2]](https://www.austriancenter.com/wp-content/uploads/2016/05/GIS_2-300x116.jpg)
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November 29th, 2016
The future of OPEC
by Frank Umbach In the era of conventional oil, countries made […]
by Frank Umbach
In the era of conventional oil, countries made decisions based on prices above $100 per barrel. The Organization of the Petroleum Exporting Countries (OPEC), led by Saudi Arabia, essentially set the global oil price. Now, it is shale oil production in the United States that determines prices. Diverging geopolitical interests among OPEC’s members have eroded trust within the organization. This lack of trust makes it more difficult to enforce collective decisions that would be mutually beneficial. However, even if OPEC manages to freeze or cut production, the impact on the oil price will likely be limited, unless major non-OPEC producers such as Russia and the U.S. get on board. Moscow has voiced a willingness to join in such an action, but could renege at any time.
Since the 1970s, OPEC had been the most influential actor in the oil market. Its production held relatively stable, and the organization limited its spare capacity to balance supply and demand. Before 2014, OPEC controlled more than 40 percent of the world’s oil output – much less than the nearly 50 percent share of its heyday in the mid-1970s.Two years later, its market share is even lower. From early summer 2014 to January 2016, the oil price sank from $107 to just $27 per barrel. At the time, it was forecast that prices would climb back to $60-70 per barrel by the end of 2016. But by November, they were still under $50 per barrel.
The likelihood of prices rising much higher than $60 per barrel has not improved over the past year. While OPEC coordinates the oil policies of its member states to ensure steady income and a stable market, Saudi Arabia has always been the dominant producer and has had the most influence. However, the Saudis have waged a price war since 2014 with the goal of forcing U.S. shale oil production to collapse. That effort has largely failed.
Upcoming meeting
In the old oil era, Saudi Arabia was not just the world’s biggest producer and largest exporter (with 15 percent of the global market). It also held the largest spare capacity – considered the “nuclear weapon” of the global oil market. This gave Riyadh unrivaled influence. But its ability to act unilaterally within OPEC undermined the organization’s role as a price setter. Since 2014, the Saudis have been less willing to have OPEC maintain that role for both economic and geopolitical reasons. The U.S has reduced its engagement in the Middle East and Saudi Arabia faces the prospect of a rising regional rival in Iran. Riyadh has no interest in seeing Tehran gain economic sway through rising oil revenues.
In 2017, non-OPEC oil production is expected to grow by at least 200,000 barrels per day from 2016 levels. After informal talks in Algiers in September, OPEC announced that it would work out a plan to cut output between 250,000-750,000 barrels (just 1-2 percent, to about 32.5-33 Mb/d) ahead of its next ministerial meeting on November 30. There was no agreement on how to split the cut between members.
OPEC members were split on the topic of whether to cut production at the September 2016 informal meeting in Algiers (source: macpixxel for GIS)
While low oil prices benefit consumers and importing nations, they hurt high-cost producer countries – in particular, those whose budgets are highly dependent on oil exports. Even Saudi Arabia ran a budget deficit of $98 billion in 2015 (16 percent of its GDP), with a deficit of $87 billion projected for 2016. Riyadh has cut government salaries by 20 percent and reduced public spending.
In the short term, OPEC faces a dual challenge. The first is U.S. shale oil output and the second is a substantial production increase in Iran, Iraq and elsewhere.
U.S. shale
In the old oil era, emerging markets such as China drove ever-rising demand. Conventional oil production increased with new investments in ultra-deep offshore fields (such as Brazil’s sub-salt fields), remote areas (the Arctic, Siberia) and Canada’s oil sands – all high-cost production options. But between 2010-2015, combined conventional and unconventional U.S. oil production nearly doubled from slightly more than 5 Mb/d to 9.4 Mb/d at a cost of between $40 and $80 per barrel. In 2015, 52 percent (4.89 Mb/d) of total U.S. crude oil production came from shale (tight) oil – equal to almost half of Saudi Arabia’s production. Due to low oil prices, the number of oil rigs in the U.S. has dropped by 80 percent and oil production has decreased to 8.5 Mb/d. More than 100 companies have gone bankrupt and some 120,000 jobs have been lost since the beginning of 2015.
However, U.S. shale production has slowed far less than expected because of increased efficiency, operational cost cuts and improving technology. Average production costs have fallen by 30 to 40 percent for U.S. shale wells, compared with just 10 to 12 percent elsewhere. About 60 percent of U.S. shale oil output is now considered commercially viable at $60 per barrel; only 20 percent of conventional deep water oil production is. The shale oil industry has proven much more flexible due to its short drilling cycle – it does not require large upfront investments to recover quickly when prices rise. By the end of 2017, production levels may increase by 600,000 to 700,000 barrels per day. Investors are already interested in new opportunities of shale oil projects.
U.S. oil producers have increased efficiency. About 60 percent of American shale oil output is now considered commercially viable at $60 per barrel (source: macpixxel for GIS)
Shale oil production may even jump from 4.5 Mb/d in 2015 to 8.5 Mb/d by the mid-2020s. New deposits from which it should be cheaper to extract oil have been discovered. A case in point is the Permian Basin in Texas, where average breakeven prices range between $35 and $40 per barrel – in some fields it may even fall below $30. Most of the 150 new rigs in the U.S. have been installed there. The Permian Basin is home to the largest number of drilled but uncompleted wells in the U.S. – 1,348 as of August 2016. This will become a large source of production as oil prices rise. In the coming years, waterless fracking, laser drilling and other new technologies will make shale oil extraction safer, cleaner, leaner and more competitive.
A new study by Rystad Energy confirmed the U.S.’s strengthening position in the global oil market. It concluded that, for the first time in history, the U.S. holds more recoverable oil reserves (264 billion barrels) than both Saudi Arabia (212 billion barrels) and Russia (256 billion barrels). More than half of U.S. oil reserves are shale oil, compared with 30 percent globally. If President-elect Donald Trumpfulfills campaign promises to lower taxes and ease environmental regulations, the U.S. shale oil and gas industries will get a further boost.
Iran and Iraq
A weakening of OPEC may help emerging oil powers Iran and Iraq raise production and expand market share. Iran is OPEC’s third largest producer, holding 9.3 percent of global oil reserves. At the September meeting, Tehran rejected calls for it to reduce output along with other OPEC members. Iran is currently pumping out 3.6 Mb/d and is unwilling to freeze output until it regains the production levels (4 Mb/d to 4.2 Mb/d) and market share in OPEC (13 percent) it had before the West imposed sanctions. It even aims to increase production to 5 Mb/d within three years. Iran is in a better position to keep output high and endure low prices than other OPEC members – oil revenues account for a much smaller share of its state budget.
Iraq, OPEC’s second-largest producer, is also looking to increase production. It has been exempt from past OPEC quotas due to its recent history of war and sanctions. But its output over the last two years has grown from 3.2 Mb/d to 4.35 Mb/d in 2016. It plans to expand production to 6 Mb/d by 2020 and wants to reach to 7 Mb/d thereafter.
In addition, production levels of Libya and Nigeria were up for negotiation after OPEC’s Algiers meeting. Both countries have seen output and market share drop due to domestic violence. In particular, Nigeria’s oil production could see a big rise if it manages to regain stability. Its production declined to just 1.27 Mb/d at the end of 2015 after averaging 1.8 Mb/d throughout the previous year.
OPEC rising
OPEC could regain its heft in global markets if the following developments play out:
• In 2015, global investment in the energy sector fell 8 percent, with the upstream oil and gas sector seeing the biggest decline in its history. The oil majors have shelved new high-cost projects worth some $400 billion. The collapse in investment has already resulted in a dramatic decline in the discovery of new oil fields. This state of affairs could trigger a global supply shortage and unpredictable price spikes if demand for oil rises sharply. The security of global oil supply could even be threatened, leading to new geopolitical rivalries.
• Spare capacity globally has significantly decreased, meaning unrest in Libya, Iraq, Nigeria or Venezuela could easily disrupt oil supplies enough to cause a shortage. Even Saudi Arabia’s spare capacity is limited. Even as the “global central bank of oil,” it can only increase production from its current 11.5 Mb/d to 12.5 Mb/d.
• A scenario where oil prices remain low for an extended period could leave high-cost oil fields stranded and push some countries out of the market. This would fuel domestic instability in those states, but could also make the world more dependent on the few low-cost producers in the Middle East. In this scenario, the security of global oil supply would be less diversified, more insecure and less resilient against unanticipated disruptions.
However, oil stocks have accumulated over the past two years and now stand at a record level of 3.09 billion barrels. This reserve could function as a substitute for limited spare capacity, at least in the short term. The more realistic scenario is that OPEC will become marginalized.
Diminishing influence
Many OPEC countries are not low-cost producers and member states’ interests are becoming increasingly divergent. This has made it more difficult for the organization to agree on new production limits. From this perspective, an effective freeze or cut in production seems difficult to achieve and even more unsustainable in the long run. OPEC’s history has shown that members often do not adhere to agreements to freeze production.
Most experts do not expect oil prices to rise above $60 through 2017, and instead predict that a price floor of $40 and $60 will emerge. The new, skeptical forecasts stem from additional supply coming onto the markets. This includes more U.S. shale oil, higher output from Norway and the long-delayed restart of production from the giant Kashagan field in Kazakhstan, which is expected to yield up to 230,000 barrels per day by the end of this year and 370,000 barrels in 2017. Even considering predictions that output from currently operational oil fields could decrease by 4.2 percent, new projects could add another 2.7 Mb/d of net supply to the already glutted global oil market. The International Energy Agency (IEA) downgraded its latest forecast for demand growth in 2017 by 100,000 barrels per day, to 1.2 Mb/d. The change was largely the result of China’s economic slowdown, which is expected to continue.
Russia’s oil fields will begin to run dry soon. Since it has been unable to expand production beyond its present, post-Soviet record high of 11.1 Mb/d, Russia has expressed its willingness to support an OPEC production freeze. It needs an oil price of $65-75 per barrel for its operations to be profitable. However, Moscow has so far committed to nothing specific and its “support” might prove short-lived: an oil price above $60 would stimulate a rapid increase in U.S. tight oil production, which is already recovering and expected to expand again next year. That would add more oil to the global market, pushing prices back down below $40 per barrel.
Any deeper or longer lasting production cut from OPEC could ultimately prove self-defeating. Reaching a price level high enough to generate financial relief for its members but low enough to keep high-cost producers from reentering the market demands sophisticated micromanagement of global oil prices. This seems impossible, particularly considering that OPEC and non-OPEC producers have not been able to agree on a production cut in 15 years.
In the long-term view, Saudi Arabia appears to have lost trust in its oil reserves as the best instrument to preserve economic stability and regional influence. This is a consequence of climate protection policies worldwide, technological advances in the energy sector, the increasing use of renewables and the rising popularity of electric and hybrid vehicles. The transport sector still depends on oil and gasoline for 90 percent of its fuel and accounts for 55 percent of total oil use worldwide. But the transition from fossil fuels to a low-carbon economy could take place faster than the oil and gas industry expects. The kingdom’s influential Deputy Crown Prince Mohammed bin Salman has already announced a “Vision 2030” plan that aims to boost the country’s non-oil revenues, which currently only stand at 10 percent of the total.
Related Articles:
Source: Geopolitical Intelligence Service
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