Excess inventories, weakening demand growth, and oil prices some $15 a barrel lower than this time last year left OPEC and its allies little choice but to roll over their production cuts into 2020.
Although no one at OPEC officially speaks about targeting higher oil prices, the ultimate goal of the cartel and its de facto leader Saudi Arabia is a higher price of oil and, consequently, higher revenues for the petro states whose economies rely on oil exports.
By aiming for higher oil prices, however, OPEC is inadvertently helping rival non-OPEC production, especially U.S. shale.
U.S. oil production has been smashing records in recent months, but the pace of America’s production growth has noticeably started to slow this year in response to the 40-percent oil price plunge in the fourth quarter of 2018.
If OPEC’s cuts manage to draw down inventories and if a resolution to the U.S.-China trade dispute improves outlook on oil demand, the vicious circle with higher oil prices leading to booming U.S. supply, leading to high inventories leading to depressed oil prices will roll again.
That’s because Saudi Arabia’s budget breakeven price is estimated at US$80-85 a barrel Brent, and the Kingdom appears to be fighting for higher oil prices instead of market share.
At $80 Brent, with WTI Crude normally trading at a discount to Brent, all U.S. production areas, shale or non-shale, would easily be profitable, according to the Dallas Fed Energy Survey for Q1 2019.
But after oil prices slumped in Q4 2018, U.S. production growth has slowed down this year, despite the fact that it reached an all-time high of 12.162 million bpd in April 2019, as per EIA data. According to EIA data compiled by Reuters analyst John Kemp, U.S. production growth of crude oil and condensates was 1.52 million bpd year on year for the three months between February and April 2019, compared to an annual growth rate of nearly 2 million bpd—1.97 million bpd—in the period August to October 2018.
Considering that there is a nine to twelve-month lag between an oil price slump and actual production, U.S. production growth could continue to slow through the end of this year in response to the plunge in prices in Q4 2018, Kemp argues.
Several signs already point to slowing drilling activity and production growth.
The U.S. oil rig count is currently down by 65 rigs from this time last year, according to Baker Hughes data. Despite the rig decline year on year, U.S. production is almost 1.2 million barrels per day higher year on year—the equivalent of OPEC’s production cut agreement.
According to the Q2 Dallas Fed Energy Survey of oil and gas executives, activity in the oil and gas sector was flat in the second quarter of 2019 after three years of growth. While oil and gas production rose for the 11th consecutive quarter, the oil production index indicated a slightly slower rate of growth. The index for company outlook pointed to more pessimism about future conditions, coinciding with a surge in uncertainty, with the uncertainty index surging 31 points to 50—the highest level since the index was introduced in 2017, the survey showed.
Despite moderating growth, U.S. production will continue to rise and offset to a large extent OPEC and allies’ efforts to reduce global inventories. OPEC and its Russia-led non-OPEC partners in the production cut deal are aiming for higher prices right now, even if this means ceding market share and having OPEC’s share of global oil production drop next year to below 30 percent for the first time since 1991, according to Bloomberg News estimates.
“I have no doubt in my mind that U.S. shale will peak, plateau and then decline like every other basin in history,” Saudi Arabia’s Energy Minister Khalid al-Falih said in Vienna this week, as reported by Bloomberg.
But Saudi Arabia and OPEC may have to wait at least half a decade to a decade for U.S. shale to peak, as many estimates put shale peak at around 2025 or later.
Every time Saudi Arabia and OPEC see their coveted $70-80 oil price on the horizon, U.S. shale is set to respond with higher drilling activity and production.
Derek Brower, director at research firm RS Energy Group, summed it up for the Financial Timesthis week:
“Opec is going to keep inadvertently subsiding shale.”