At the Midway-Sunset oil field in California, the prize lies fairly close to the surface, so the wells do not have to be very deep. The oil in the Monterey Shale is much less accessible. Jim Wilson/The New York Times Source.
Saudi Arabia and the core Opec states are taking an immense political gamble by letting crude oil prices crash to $66 a barrel, if their aim is to shake out the weakest shale producers in the US. A deep slump in prices might equally heighten geostrategic turmoil across the broader Middle East and boomerang against the Gulf’s petro-sheikhdoms before it inflicts a knock-out blow on US rivals.
Caliphate leader Abu Bakr al-Baghdadi has already opened a “second front” in North Africa, targeting Algeria and Libya – two states that live off energy exports – as well as Egypt and the Sahel as far as northern Nigeria. “The resilience of US shale may prove greater than the resilience of Opec,” said Alistair Newton, head of political risk at Nomura.
Chris Skrebowski, former editor of Petroleum Review, said the Saudis want to cut the annual growth rate of US shale output from 1m barrels per day (bpd) to 500,000 bpd to bring the market closer to balance. “They want to unnerve the shale oil model and undermine financial confidence, but they won’t stop the growth altogether,” he said.
There is no question that the US has entirely changed the global energy landscape and poses an existential threat to Opec. America has cut its net oil imports by 8.7m bpd since 2006, equal to the combined oil exports of Saudi Arabia and Nigeria.
This chart, taken from the Financial Times on Dec 1, 2014, shows how price of oil has plunged in the last six months
The country had a trade deficit of $354bn in oil and gas as recently as 2011. Citigroup said this will return to balance by 2018, one of the most extraordinary turnarounds in modern economic history.
“When it comes to crude and other hydrocarbons, the US is bursting at the seams,” said Edward Morse, Citigroup’s commodities chief. “This situation is unlikely to stop, even if prevailing prices for oil fall significantly. The US should become a net exporter of crude oil and petroleum products combined by 2019, if not 2018.”
Opec has misjudged the threat. As late as last year, it was dismissing US shale as a flash in the pan. Abdalla El-Badri, the group’s secretary-general, still insists that half of all US shale output is vulnerable below $85.
This is bravado. US producers have locked in higher prices through derivatives contracts. Noble Energy and Devon Energy have both hedged over three-quarters of their output for 2015.
Pioneer Natural Resources said it has options through 2016 covering two- thirds of its likely production. “We can produce down to $50 a barrel,” said Harold Hamm, from Continental Resources. The International Energy Agency said most of North Dakota’s vast Bakken field “remains profitable at or below $42 per barrel. The break-even price in McKenzie County, the most productive county in the state, is only $28 per barrel.”
Efficiency is improving and drillers are switching to lower-cost spots, confronting Opec with a moving target. “The (price) floor is falling and may not be nearly as firm as the Saudi view assumes,” said Citigroup.
Mr Morse says the “full cycle” cost for shale production is $70 to $80, but this includes the original land grab and infrastructure. “The remaining capex required to bring on an additional well is far lower, and could be as low as the high-$30s range,” he said.
Critics of US shale may have misunderstood its economics. There is a fast decline in output from new wells but this is offset by a “long-tail phase” for a growing number of legacy wells. The Bakken field has already reached 1.1m bpd, and this is expected to double again over the next five years.
Other oil projects around the world may be more vulnerable to a price squeeze, including the North Sea, the ultra-deepwater ventures in the Atlantic off Brazil and Angola, Canadian oil sands, or Russia’s contentious plans for the Arctic in the “High North”. But the damage will be gradual…
The Saudis deny that they have any such motive. But they can well afford a spell with low oil prices, unlike Iran, who is most upset. Do read the last link on Iran, as they are, predictably, blaming the low prices on the West.
The economies of the Western countries are far more diversified, so the USA and Canada, despite the problems the low prices are causing, are not likely to break quickly, especially since the low prices help other sectors in the economy.