Has OPEC Finally Pushed U.S. Shale Over the Edge?

By Oil FOXBusiness

Major drop in U.S. shale production predicted

PRICE Futures Group's Phil Flynn on the outlook for oil prices.

­­­­Since June 2014 when global oil prices began their downward spiral, the price of oil has collapsed more than 70%.

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The once resilient U.S. energy industry is showing intense signs of strain. ExxonMobil (XOM), the biggest player in the space, may lose its pristine triple-A rating as its profits have swooned.

Meanwhile, some smaller exploration and production companies have seen their stock prices collapse as investors question their viability. In a sign of the pressure, the risk premium investors demand to hold the debt of junk-rated U.S. energy companies climbed to a record high earlier this month -- even surpassing levels hit during the financial crisis, Bank of America Merrill Lynch (BAC) data show.

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The U.S. shale revolution that catapulted America high on the list of the world's biggest oil producers helped inflate a global glut of supply that only worsened as the Organization of the Petroleum Exporting Countries (OPEC) kept spigots open in a bid to regain market share.

With West Texas Intermediate, the U.S. oil benchmark, hovering near the $30-a-barrel mark, and conditions worsening in the shale space, has OPEC's bet finally paid off? 

Suzanne Minter, manager of oil and gas consulting at Platts Bentek products, said she doesn’t see OPEC cutting production. She said the global oil market is at a tipping point right now – having fallen so far so fast from all-time highs – that to give in and cave to U.S. producers would be seen a huge concession for the cartel.

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“They are so close to making North American producers roll over. They got us exactly where they want us,” Minter said.

To show just how oversupplied the market remains, on Wednesday, weekly inventory data from the Energy Information Administration, showed a record-high level of commercial crude inventories excluding stockpiles at the Strategic Petroleum Reserve. Inventories rose by 3.5 million barrels from the prior week to 507.6 million barrels.

Over the last 52 weeks, U.S. crude oil prices have plunged 34.12% as they fluctuate between the $26 and low-$30 range.

While market participants monitor the data, they also keep one ear tuned to chatter from some OPEC members, which have been floating the idea of possibly reducing output. Two weeks ago, OPEC nations Qatar and Saudi Arabia, along with non-OPEC producers Venezuela and Russia, said they would be willing to consider freezing production at January levels as long as other nations joined the pledge. On Monday, Saudi Arabia again emphasized the need to work with oil-producing nations to alleviate market volatility, saying it “welcomes any cooperative action.”

The effort could help slow output growth, which in turn would help ease the supply glut by as less product comes online at any one time.

However, Iran has stayed mum on whether it would join in on capping production, but said it would support effort from other nations to cap their market share. The Middle Eastern nation has arguably the biggest motivation to ramp up production and increase its slice of the global market share this year after U.S. and European sanctions on the nation’s oil exports were lifted in January.

Dr. Gerald Bailey, CEO of MCW Energy Group and former ExxonMobil (XOM) senior executive, said Iran has realized how tough business can be when isolated from interacting with the rest of the world, and said the nation is most likely to continue to produce no matter what.

“They might talk about how difficult things are, cut back, or toe the line with other people. And they will get a lot of pressure from Russia and the Middle Eastern countries themselves because those neighbors are not going to be happy with them doing what they’re doing,” he explained

While OPEC might be forcing the hand of U.S. shale producers, the lower-for-longer prices, and ultra-saturated oil markets were likely more than the cartel bargained for. Minter pointed to a now infamous moment in 2014 when OPEC held production steady, failing to account for the gains in technology and how creative U.S. oil producers could be in order to stay in the oil-producing game.

“They did not understand the impact of an independent versus national oil company. A lot of producers had production hedged at $85 or $90 a barrel so even though it didn’t seem to make sense on paper, we kept producing. That was OPEC’s plan – not to cut, push it out, and hold on to market share. Of every person I spoke to in the Middle East, no one expected to see $30 a barrel oil.”

The bottom line, Minter said, is production has to come off the market.

“From a purely fundamental basis, there’s no reason for prices to go much lower than they are. In reality, production in the U.S. should start to rollover here. We should see production come off as people aren’t able to maintain drilled or uncompleted wells,” she said.

Data from Baker Hughes (BHI) last week showed the North American oil rig count has dropped to 400 from 986 a year ago. Meanwhile, total international rig counts have plunged to 1,045 in January of this year from 1,258 from the same time in 2015.

 “Low prices have to stay low long enough to curtail production, and at some point, it won’t come back on. Venezuela won’t recover lost production in 30 days. Whereas, in the U.S., if prices come back, you could see one million barrels per day hit the market over 30 days. We have to find physical status quo of permanently taking out production but find increase in demand in order to allow prices to come up,” Minter explained.

The basic driver, she explained is the difference in motivation for production: In the U.S., energy companies work as businesses, and will find a way to work with persistently low prices. But in the Middle East, where in some cases energy makes up 90% of GDP, they have to produce for cash flow.

“My call for 2106 is that OPEC nations and Russia will produce more than they say they will because they have to sell more for less money because they need the revenue. Venezuela doesn’t have much clout and its economy is crumbling. Low prices will make them not have enough capital to maintain current output. So, at that point, you get a natural decline that happens in the rest of the globe,” she said.