Monday, December 01, 2014

Playing with Fire

Ambrose Evans-Pritchard, in the UK Telegraph, on Saudi Arabia's gambit to curb U.S. shale oil production by letting oil prices tumble--a strategy that may quickly backfire:

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.  


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. 
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. 

As Evans-Pritchard writes, the Saudis (and the rest of OPEC) badly misjudged the threat posed by U.S. and Canadian shale oil production; as recently as last year, senior officials in the kingdom were dismissing shale as a flash in the pan--nothing more than a temporary inconvenience for the oil barons of the Middle East.

Now, the Saudis believe falling crude prices--perhaps going as low as $40 a barrel--will force some shale producers to reduce production and lay off workers.  But some American firms are one step ahead of OPEC, hedging much of their output for 2015 and 2016 at higher prices, set before the recent drop.  Additionally, shale producers can additional wells on line at a much lower cost, since the biggest expenses (including land acquisition) have already been absorbed.  That means new wells can remain profitable--even if the price floor dips to around $40 a barrel.

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. 

[Edward] Morse, commodities chief at Citigroup, 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. 

Indeed, the economics of cheap crude don't work for Saudi Arabia and most of the world's other oil exporters.  The break-even point is $98 a barrel for the House of Saud and even higher for countries like Russia ($105); Iran ($131), Iraq ($111) and Venezuela ($161).  Falling oil prices are creating havoc for national budgets that depend on energy exports, and the current trend could prove catastrophic for regimes in Libya, Yemen and even Algeria, which have only a tenuous hold on power.

Meanwhile, regional instability is creating new opportunities for ISIS and other Islamic terrorist organizations, which could gain control of more oil fields in places like Libya and Nigeria.  There is also the matter of Iran or Russia formenting new crises, to boost crude prices and force concessions from countries dependent on their energy supplies (read: Western Europe).

All the more reason to accelerate energy production in the U.S., and become a net exporter of crude and natural gas.  There is more than a touch of irony in all of this; first, the fracking revolution will achieve what everyone said was impossible--allowing America to become energy independent, with all the power and privileges that come with that status.  Secondly, as the oil producers of the Middle East slide further into chaos, they will call on--you guessed it--the United States to rescue them from the fundamentalist forces they unleashed.  At what point do we decide enough is enough and tell them to take that proverbial flying leap?


Just My 2¢ said...

I'm a petroleum engineer. Decisions by state-owned oil companies have a huge impact on the petroleum market because the vast majority of world crude oil production is owned by national energy companies. This makes crude oil pricing a common political issue.

Remember that in the late 1980's, President Reagan negotiated with the Saudis in secret to depress world oil prices in order to weaken the economy of the USSR. History shows that it worked... at the expense of energy company staff such as myself.

Yeah, depressed oil prices are a function of larger supply, but don't underestimate the impact on world economies and the role of strategic politics.

The Savage Possum said...

With the "Howdy" lead in, you must be an Ag. I agree with your statement having lived through 3 busts in O&G pricing. The other net effect is the large & major O&G companies will start to bail out of the stylish market of resource plays with their hyperbolic declines in production. All-in-all, resource plays are a Ponzi scheme based on lease availability. In the USA, the majors are going to make the "Ma & Pa" oil companies rich once they wake up to the fact that they can't economically support their plays without additional adjacent land to drill on & as those high IP's decline (to 25 BOPD over 60 years).

TrT said...

The article in question uses two different price measures.
It costs shale drillers 40dollars to pump a barrel.
It doesn't cost Venezuela 4x that.
They need 4x that to fund their government from oil.

I still maintain that shale is a very secondary target here.
The saudis take a lot of #%*£ from the smaller members of OPEC like Venezuela and Iran, who like to talk tough and expect Saudi to actually make the sacrifice for them.
And Russia, who's hostility was always going to provoke a response.

High oil prices don't benefit the Saudis if the money bankrolls a host of hostile regimes.