Energy ... Oil and Gas
OPIC Oligopoly

Tectonic shifts in the power of OPIC to control production

Burgess COMMENTARY

Peter Burgess

Good Morning Oilpro Readers.

In this oversupplied market, OPEC has been producing 32.1 mmbpd, above their stated quota of 30.0 mmbpd. This context made OPEC's meeting last Friday in Vienna a seminal moment in the 2015 downcycle. But al-Badri knocked the wind out of expectant OPEC watchers when he skipped the part about production levels and quotas in his official statement. OPEC appeared to kick the can, rendering quotas meaningless and suggesting that a production free-for-all lies ahead.

With delegates unable to agree on virtually anything (we wonder if arguments erupted over the take-out menu as the meeting ran longer than usual), OPEC has reached a stalemate. Each member supports cuts from every other producer, but each will pump near their own max to offset price declines with volume.

OPEC, meet capitalism. Capitalism, OPEC. The oligopoly's ability to control prices is gone for now as each member acts in their own self-interest in an oil-market transformed by US light tight oil (LTO).

Some members are playing the long-game and others the short-game. Either way, the result is the same: production above targets. For example, Saudi oil minister Ali Naimi fears an oil-market 'Black Swan' in the long-run. This is the idea that peak oil demand plus new supply sources could devalue and strand the Kingdom's vast oil reserves over the next 40 years. This risk means Saudi must pump as much as possible now. In the near-term, Iran is shoving its way into the room of exporters, but no one is willing to make room for them next year, especially lesser OPEC nations who will struggle to fund social spending in 2016.

US oil prices have fallen 13% since the meeting. That's because the disharmony and implied shift to 'petro-capitalism' could send OPEC production higher by millions of barrels per day in 2016, a notion that rattled the markets. Did anything really change last week in terms of OPEC policy? Nope. But that's the point.

A realization is growing in the market that OPEC is powerless to support prices right now as the group is in full-out price discovery mode. The only way OPEC saves the price of oil now is if it becomes 'GLOPEC' - non-OPEC producers would have to also curb their production to elicit a Saudi cut. This kind of global participation seems highly unlikely.

Since the meeting, enough OPEC commentary has been written to fill a good-sized library. Some argued OPEC is dead, while others argued reports of OPEC's death have been greatly exaggerated. As my colleague Jeff Reed pointed out last week, OPEC's inaction seems to violate its mission statement. This is akin to malpractice, but malpractice doesn't equal death. In the best OPEC piece we've read all year, Antoine Halff argued that while OPEC production cuts have been rendered counterproductive by LTO, the group is implementing an effective oil market strategy. OPEC is not dead, just different.-- Joseph Triepke, Oilpro Managing Director

http://energypolicy.columbia.edu/on-the-record/opec-s-policy-challenge-age-shale-oil

ON THE RECORD ... OPEC’s policy challenge in the age of shale oil

Thursday, December 3, 2015

By Antoine Halff

A year after its decision not to cut production in the face of low prices, there is no question that OPEC is feeling the pinch of continued market weakness. Prices have sunk further and the market remains vastly oversupplied – to the tune of 1 million barrels per day (bpd). But the severe strain under which it finds itself will not likely cause the producer group to reconsider its decision and go into policy reversal when it meets on 4 December in Vienna. Last year’s watershed move, which some of OPEC’s core members – Saudi Arabia and Iraq – followed up with steep production gains, was widely misread as a sort of abdication. In fact it merely reflected the realization that new market conditions – namely the U.S. shale revolution – called for new policy measures.

To understand OPEC’s policy, it is critical to look beyond the oil market’s imbalance and the surging oil inventories resulting from a persistent, sticky supply surplus, despite recent declines in shale output. The deeper issue involves the changing anatomy of global supply and the transformative impact of shale oil production. At roughly 4.5 million bpd, US shale oil production accounts for less than 5% of the overall oil market. But shale is a disruptive technology that challenges the industry’s long-established business model and the rules of the game for OPEC.

There are at least three reasons why shale oil makes OPEC production cuts a less palatable, less effective and less practical policy tool than in the past, if not a counter-productive one, at least for now.

Rightly or wrongly, shale oil has turned the long dominant narrative of supply scarcity on its head. The surge in oil prices to a $147/barrel record for WTI crude in July 2008 had been driven by the perception that oil was a finite and fast-depleting resource straining to meet runaway demand growth from China and other emerging economies. Prices, it was then thought, had nowhere to go but up. Today, in contrast, shale oil’s success story has unlocked vast resources and oil reserves have been reassessed, even as emerging-market oil demand has abruptly dropped to a lower gear. As the Paris climate talks gain momentum, producers get a gnawing feeling that oil demand, far from growing forever, might soon reach its peak.

This might look like a long-term concern, but for major resource holders like Saudi Arabia, such long-term worries have short-term implications. Expectations of future demand weakness and resource abundance raise the threat of stranded assets and change the revenue optimization equation. Since the Organization of Arab Petroleum Exporting Countries (OAPEC) Abu Dhabi meeting of December 2014, Saudi Oil Minister Ali Naimi has pointedly and repeatedly come back to his idea of an oil-market “Black Swan” – the risk for the Kingdom of finding itself in 2030 or 2040 sitting on top of an ocean of worthless oil. How such concerns translate into Saudi production policy is unclear, but they are very much on the mind of OPEC’s largest and most influential member.

A second way in which shale changes the equation for OPEC is by redrawing the trade map. While oil product demand continues to creep up, the crude oil market is shrinking and migrating eastward. In just a few years, the U.S. has emerged as the world’s top producer of oil liquids and of natural gas; once the largest importer of refined products, the US is now their largest exporter. US shale supply went from zero to roughly half of the country’s crude production (and 60% of its natural gas supply). Crude oil imports backed out of North America must fight for a piece of a diminishing market now heavily concentrated in Asia, notably China. The crude market, as the Norwegian oil economist Oysten Noreng has noted, is morphing from an oligopoly – in which a few sellers dominate the market – to a oligopsony dominated by a small group of buyers, led by giant state-owned Chinese companies with growing market power. For producer countries seeking to lock in and expand their footprint in China and the region, this makes it tricky to implement and allocate supply cuts.

The third and even more potent way in which shale oil is preempting OPEC production cuts is by its greater price elasticity than that of conventional supply and the challenges this raises for the rest of the industry. Conventional oil companies are huge, long-established, deep-pocketed, highly specialized, inherently conservative, and have long operated under a price umbrella or some sort or another. Shale oil companies are the opposite: small, newly-minted, nimble, innovative, highly leveraged, constantly adapting to changes in market conditions. Compared to conventional oil, shale oil has low initial capital requirements (fixed costs) but high ongoing funding needs (variable costs), short lead times, short payback times, and steep decline rates. It is much more price responsive than conventional oil. Not surprisingly, shale supply has been among the first production to cave in under the impact of lower prices, but it may be first to come back when prices rebound. The shale revolution has turned oil into a two-speed industry, split between a relatively small short-cycle shale sector and a larger, longer-cycle conventional sector. Spurred by lower prices, technological progress and advances in project management are making the shale oil business cycle shorter all the time

Since shale oil supply growth accelerated around 2012, its short cycle and price responsiveness have eroded OPEC’s capacity to manage the market via production cuts, as the price support thus provided effectively enables continued shale investment to quickly translate into new supply. OPEC cuts thus amount to a form of subsidy and a transfer of market share to the shale industry.

Does that spell the end of OPEC as an organization and market power? Nothing could be further from the truth. Its high supply policy is already scoring some points. Lower prices, driven in part by surging OPEC production, have at last brought shale supply growth to a halt. Lately aggregate US shale supply (albeit with marked differences from play to play) has started to show annual declines.

So far those dips in shale supply have been more than offset by record growth from Russia, Brazil and elsewhere, but it is just a matter of time before output from those producers starts losing steam too. Faced with collapsing prices, most producers, especially those that have low buffers and depend on high oil export revenue for social spending, find it imperative to produce as much as they can. But just as they lift supply to keep revenue as high as possible, producers are cutting back on expenses by slashing longer-term investment and postponing maintenance. This will inevitably hasten and steepen decline rates from producing fields, even as it results in a dearth of new projects to offset those declines. Most analysts agree that recent gains in supply will plateau and start reversing in 2016, perhaps rapidly.

It may take another year, all things being equal, for the market to start rebalancing in earnest. But as long as shale oil accounts for all of the supply response to low prices, it would be counter-productive for OPEC to reverse course and start cutting production. That would only cause shale supply to return to the market in short order, while also slowing down the decline in other non-OPEC supply. OPEC could resume production cuts later, however. Once other non-OPEC oil supply starts falling in earnest, OPEC could find it advantageous to speed up the price rebound by cutting its own production back again, as long as shale oil’s capacity to ramp up output fails to fill the gap in other non-OPEC production. When the dust settles, both shale oil and OPEC will likely have gained market share at the expense of big-ticket, high–cost, long lead-time conventional supply from non-OPEC countries.

Some OPEC producers will undoubtedly have a hard time getting over the low-price hump. Those include virtually all OPEC producers outside of the core Middle East group. But it is unlikely that these producers will be able to prevail over their Gulf Cooperation Council counterparts. Unsavory as OPEC’s market share policy might feel to them, they will likely be forced to support it for two reasons: first, there is a shared interest among OPEC members, no matter how deep their division, in maintaining a façade of unity. No one would benefit from a public display of internal dissent weakening of the organization. Second, OPEC policy will give the oil ministers of embattled member countries political cover and help them explain collapsing revenues to their home governments and electorates.

Of course, OPEC’s actual production over the next few months will not necessarily be set by the group’s stated policy targets. The most embattled members may extract from the others some form of platonic, rhetorical support for market management. Market constraints – lack of buying from refiners –may also place a ceiling on how much production members can push onto the market. But staying the course would assuredly make more sense for the group than reversing it as OPEC seeks to adjust to a market transfigured by the advent of shale.

Antoine Halff is Senior Fellow and Director of the Global Oil Markets Research Program at the Center on Global Energy Policy, Columbia University. His 20-year career in energy spans the worlds of government, international organizations, consulting, Wall Street, higher education and the media. He joined the Center in September 2015 from his previous position as Chief Oil Analyst at the International Energy Agency (IEA) and editor of two of its most authoritative publications, the monthly Oil Market Report (OMR) and the annual Medium-Term Oil Market Report (MTOMR).

http://business.financialpost.com/news/energy/opec-is-dead-cartel-that-once-blackmailed-nations-now-only-able-to-bully-themselves

ENERGY ... ‘OPEC is dead’: Cartel that once blackmailed nations now only able to bully themselves

Laura Hurst, Nayla Razzouk and Julian Lee, Bloomberg News |

December 7, 2015 3:42 PM ET

OPEC has abandoned all pretense of acting as a cartel. It’s now every member for itself.

So this is what winning looks like: OPEC's 'victory' against rivals comes at heavy price

While OPEC’s strategy has cancelled projects in North America, most of its own members are also struggling with massive deficits, anemic economies and rising unemployment. Read on

At a chaotic meeting Friday in Vienna that was expected to last four hours but extended to nearly seven, the Organization of Petroleum Exporting Countries tossed aside the idea of limiting production to control prices. Instead, it went all in for the one-year-old Saudi Arabia-led policy of pumping, pumping, pumping until rivals — external, such as Russia and U.S. shale drillers, as well as internal — are squeezed out of market share.

1 “Lots of people said that OPEC was dead; OPEC itself just confirmed it,” Jamie Webster, a Washington-based oil analyst for IHS Inc., said in Vienna.

OPEC has set a production target almost without interruption since 1982, though member countries often ignored it and pumped well above it. The ceiling of 30 million barrels a day, in place since 2011 and now abandoned as too rigid, is no exception. OPEC output has outstripped it for 18 consecutive months, according to data compiled by Bloomberg. Now the organization says it will keep pumping as much as it does now — about 31.5 million barrels a day — effectively endorsing limitless output.

‘It’s Ceilingless’

FP1207_OPEC_Spare-GS-C

The oversupply has sent the price of Brent, a global oil benchmark, to a six-year low, triggering the worst slump in the energy sector since the 2008 world financial crisis. It’s cut the profits of major oil companies such as Exxon Mobil Corp. and BP Plc in half while crude-rich countries such as Mexico and Russia have watched their currencies plunge and their coffers shrink.

Americans don’t have any ceiling. Russians don’t have any ceiling. Why should OPEC have a ceiling?

West Texas Intermediate extended losses below $40 a barrel, dropping as much as 81 cents, or 2 percent, to $39.16 on the New York Mercantile Exchange at 6:55 a.m. Monday. Brent crude in London slid as much as 1.3 per cent to $42.46.

On Friday, there was no talk of even setting a production target that member countries could then disregard.

“Effectively, it’s ceilingless,” said Iranian Oil Minister Bijan Namdar Zanganeh. “Everyone does whatever they want.”

Emmanuel Ibe Kachikwu, the Nigerian minister, reinforced the message, saying the market shouldn’t worry about the “semantics” of targets or real production.

“We aren’t going to go back to a cartel and work against the customers — that time has passed,” said United Arab Emirates Minister Suhail Al Mazrouei.

http://www.forbes.com/sites/woodmackenzie/2015/12/07/opec-still-relevant-to-the-oil-market/

DEC 7, 2015 @ 11:36 AM

Skip York, Forbes Contributor

OPEC: Still Relevant To The Oil Market

TWEET THIS ... How much and how fast the Iranians get crude back into the market is a daily discussion in every OPEC oil ministry today

With some industry observers stating that OPEC’s days are numbered, my colleague Ann-Louise Hittle and I reckoned that much like Mark Twain, OPEC members may have been thinking over the weekend that reports of the cartel’s demise had been greatly exaggerated.

Ten years ago, OPEC supplied 35% of world demand; the current 31 million barrels of crude oil output its members produce each day is about 30% of world oil demand. That share looks set to grow in the medium term to 2020 due to significant investment cuts by non-OPEC producers. Wood Mackenzie estimates that oil and gas companies have cut upstream investment in new developments by $276 billion over the next few years by deferring new conventional projects and unconventional drilling.

OPEC relevance lowest in a decade, but still over 30% of the oil market

OPEC appears to be coming to the realization that global oil market dynamics have changed, but one thing that hasn’t is the need for OPEC to play a role. For over a year OPEC has been in classic price discovery mode while seeking to maintain market share. The oil consortium rightly concluded in November 2014 that curtailing production to support some price level would simply lead to additional OPEC production cuts at subsequent meetings. It reached the same conclusion this past June and again at its meeting last Friday.

It is largely the Saudis who decided OPEC needs to undertake this ‘voyage of discovery’. Two key elements of the future oil market are – how member countries manage their resources and how they make investment decisions to maintain or grow capacity. Most people have forgotten it was the Saudis who realized it wasn’t healthy for either the oil market or the global economy when prices went over US$140/bbl in 2008. They developed two million barrels of capacity per day and are willing to keep it in reserve as a buffer against future price spikes.

No other nation or company in the world would invest billions of dollars to develop oil-producing capacity with the intent of not using it. They invested the money, got that spare capacity, and then all this US tight oil showed up. All of OPEC, not just the Saudis, need to understand what the new pricing structure will be so they can manage both their future role in the world oil market and their respective nation’s expectations of oil revenue.

There’s another fly in the ointment. How much and how fast the Iranians get crude back into the market is a daily discussion in every OPEC oil ministry today , just like it is in every corporate executive suite I visit. Iran’s return to the market is being met, so far, with a bearish response – particularly if the growth in Iranian barrels manages to compensate for the decline of non-OPEC supply and meet global demand growth. I doubt many OPEC members have the appetite to accommodate increasing Iranian exports for a host of reasons. Meanwhile, most of the statements by Iran’s oil minister – along the lines of “one million barrels per day within months” – are more an exuberant response to the end of sanctions than what might be technically possible or commercially viable.

There is also a bit of a self-correcting mechanism in the global oil market. If the growth in Iranian exports exceeds expectations, it likely would place downward pressure on price. That low-price environment means the decline in non-OPEC supply will happen faster and stronger than expected as we move through 2016 – with well-head realizations dropping below operating costs for more existing wells, and even deeper capital spending cuts.

For me, the big question for OPEC is how it plays its role from this point. It will be fascinating for both OPEC and non-OPEC producers to understand the price discovery process. What does the marginal barrel look like? Where is it? How price elastic is it? How quickly can it respond to a change in the market? Answering these questions will take a while. As Ann-Louise pointed out, the several price convulsions the market has endured this year shouldn’t surprise anyone – they are part of the industry learning how new technologies and techniques, such as tight oil, impact setting oil prices.

I was surprised by several comments made after Friday’s meeting that OPEC proved it isn’t relevant by not making a cut. It’s as if they believe the organization is obligated to act, even if the action would be futile. Ann-Louise and I both agree that when the dust settles and these answers are known, there will still be an OPEC and it will still play a critical role in balancing the global oil market.