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Opec gambles against US tight oil amid low oil prices

They may not realise it yet, but the US’ tight oil producers are in a game of who-blinks-first with Opec

A few things are clearer after Opec secretary-general Abdalla El-Badri’s appearance at the Oil & Money conference in London on 29 October and his briefing to journalists there.

1. Barring another steep drop in the oil price in the next couple of weeks, Opec is highly unlikely to cut output at its meeting in Vienna on 27 November

Saudi Arabia has already signalled to the market that it is reluctant to act alone to support prices. It has also spent recent weeks competing for market share with some local rivals, including Iraq and Kuwait.

Judging from El-Badri’s words on 29 October, there is little push coming from the secretariat, either. He said the call on Opec next year would range from 29 million to 30m barrels a day (b/d), which would leave it roughly in line with the 30m b/d he said the group was producing.

Group outsiders will challenge those numbers. The International Energy Agency (IEA) thinks the call will be only 29.3m b/d next year, while a recent survey from Platts, a pricing agency, put Opec output at 30.6m b/d. So if left unchecked, the oversupply could reach 1.3m b/d — the kind of territory that calls for cuts, not tweaks, if the price is to be defended.

For now though, there’s little sign Opec is in the mood to risk further market share deterioration in an effort to prop up the market.

2. Opec expects US tight oil to act as the swing producer for now

One reason Opec isn’t likely to cut is because, to judge from El-Badri’s words, it is convinced US tight oil producers will do the job for them. That would be a reversal of recent years, during which rising North American tight oil supply has eaten away at Opec market share, including forcing almost all West African light crude out of the US market.

El-Badri told journalists that “at least 50%” of US tight oil supply would be pushed out of supply if present prices persist. Based on Energy Information Administration (EIA) numbers, that would equate to more than 2m b/d — more than enough to clean up the overhang of supply on the market and bear out El-Badri’s forecast.

3. This is a gamble for Opec that could go wrong

Opec’s reading of North American unconventional oil supply and its vulnerability to lower oil prices is markedly different from the view those producers themselves -- and from the view of most analysts.

For some of the group’s critics, it all sounds a lot like the dismissive view Gazprom took of shale gas a few years ago. The Russian firm eventually had to shelve part of its export strategy that was based around sending liquefied natural gas to the US, which soon overtook Russia as the world’s biggest gas producer.

Speaking to the same conference in London just after El-Badri, Marianne Kah, chief economist at ConocoPhillips, which has a large tight oil position, said oil prices would have to fall to $50/b to “really harm production”. Bob Dudley, BP’s boss, similarly rejected any claim that US tight oil production was doomed at present oil prices.

The IEA reckons only 4% of North America’s tight oil supply needs a price above $80/b to break even. Rystad Energy, a consultancy, says that even at $50/b it would take 12 months before 500,000 b/d of US tight oil supply were removed from the market. To keep production in 2015 level with expected end-2014 output, a price of $60-65/b would be enough.

Opec’s more sceptical view of all this stems from the group’s own research, and El-Badri trusts it. If producers haven’t pulled back much yet, said El-Badri, it’s because many of them have hedged their product’s prices until end-2014.

He pointed to falling US rig counts to support his argument. He was referring to data from Baker Hughes, which in mid-October showed a downtrend for US rig counts over many weeks before.

But the most recent count showed an increase, and for the week ending 24 October there were 124 more rigs in operation in the US than in the same period a year earlier. So the rig data aren’t clear either way – yet. “We will see in a year,” said El-Badri.

4. The market will have to pay a lot more attention to the economics of US shale oil

They may not realise it yet, but US tight oil producers are in a game of who-blinks-first with Opec, which simply doesn’t believe tight oil can last the distance, as it can.

So assuming the group doesn’t cut in November -- and prices remain where they are or fall further -- all eyes will be on tight oil producers, watching for signs of slowing output growth or the sharp cut in supply El-Badri predicts. But the outlook isn’t straightforward. If tight oil producers begin shutting in wells, prices will rise — which could simply spur more output growth again.

Even a moderation of the pace of growth could have price effects that aren’t obvious. As the marginal production comes off, the labour and rig market should loosen, lowering costs for the rest of the producers, making the sector as a whole more resilient to falling prices. Lower margins will also force drillers and the services firm working for them to eke out higher productivity, or work on lifting their low recovery rates.

This is a process that was already underway, even before the price slump. EIA data show that output from new wells in each of the seven big US shale plays has risen in the past 12 months. Producers say the trend will continue. If so, it means that oil prices, rig counts and even spending across the tight oil sector could fall in the coming months — while production keeps growing or stays stable.

5. Tight oil isn’t the only segment of supply that is vulnerable

El-Badri pointed to deep water and other remote areas as vulnerable at current prices. The IEA says that across the industry, fully 2.6m b/d of existing output needs a break-even price of $80/b. Some planned developments — though little of existing output — in the oil sands is similarly at risk.

Is that volume of oil enough to put a floor under the price? “If the price declines, everything will be affected,” said El-Badri.

So how much of Opec’s own upstream investment is now at risk? The group wouldn’t reveal what the break-even points for its own new projects were, but El-Badri says Opec will spend $270bn to add up to 8m b/d of new production (partly to offset decline), in 117 projects, between now and 2018.

The group will need that extra oil to meet the rising call on its crude, which will increase to 50m b/d (including 10 m of NGLs) after 2020, El-Badri said. That long-term projection will be another source of debate, not least because it rests on assumptions about long-term demand that look less robust than before.

Above all, though, the world will need Opec’s oil, insisted El-Badri, “because tight oil will decline so we need to balance”. That’s a bold prediction, given the past few years — and the shale resources yet to be fully tapped outside the US.

In short, amid the fanfare proclaiming a shale revolution and some kind of paradigm shift, Opec isn’t getting excited. “Don’t panic,” was El-Badri’s message. The next year will tell the market whose version of events is right.

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