- Oil & gas industry needs $20 trillion to meet demand in next 25 years.
- U.S. shale firms unlikely to follow OPEC’s call to restrain supply.
- OPEC supply to grow by only 750,000 b/d in next five years.
- “There is a worldwide obsession with shale. It’s irrational exuberance in the U.S., and it’s irrational fear in the rest of the world.”
The OPEC and non-OPEC production cut that began at the beginning of last year has worked in the cartel’s favor. Oil prices remain above $60 per barrel, inventories have declined sharply, and demand continues to grow. One would think OPEC and its non-OPEC allies would be pleased with the results. Even though market fundamentals and prices have moved in their direction over the past year or so, major oil-producing states are still jittery about growth in U.S. shale and another possible price fall. While OPEC ministers fixate on keeping another glut from forming in the near term, their countries are not investing enough in the long run to help meet increases in demand.
The current market uncertainty has prompted OPEC officials to meet with CEOs of U.S. producers. In Houston Monday night, both sides had dinner on the sidelines of the CERAWeek by IHS Markit conference. Those who attended the meeting mostly downplayed the discussions and said they were simply part of an ongoing dialogue.
“We have compared notes. We had emerged from a severe cycle and CERAWeek gives us an opportunity to compare notes and experiences,” OPEC Secretary General Mohammad Barkindo told Bloomberg. Earlier in the day when speaking at the conference, Barkindo said that OPEC welcomes the growth in shale and is not worried about its impact.
It’s clear that OPEC is worried and wants shale companies to slow their production increases or contribute to output cuts to keep prices elevated.
However, it’s clear that OPEC is worried and wants shale companies to slow their production increases or contribute to output cuts to keep prices elevated. Growth of more than one million barrels per day (Mbd) in 2017, followed by increases of 2.5 Mbd this year and next, could cut into OPEC’s market share near term. The Nigerian oil minister said Monday that OPEC is pressuring U.S. oil companies to stabilize the global market. “It’s not just a problem for OPEC, it’s a problem for the entire industry,” Emmanuel Kachikwu, the oil minister, said in Houston, although he did not provide specific details on what exactly OPEC producers were asking U.S. firms to do.
U.S. companies are unlikely to respond to OPEC’s wishes to cut or slow output to increase prices. For one, working with a cartel or as a coordinated group to fix prices is against federal U.S. law. Second, even though OPEC says that both sides share common goals, that is not necessarily true. The shale industry includes hundreds of companies, many of which must answer to public shareholders. Unlike OPEC countries, shale firms do not have political goals, and their main objective is profit. Lower output could bring about a drop in cash flow. If anyone can pressure companies to cut back output, it would be shareholders, many of whom are frustrated with a strategy focused on growth.
Third, market dynamics are working in shale’s favor, for now at least. Higher prices have allowed companies to increase output, reduce debt, improve cash flow, hedge production forward, and boost exports. As OPEC producers have cut back to increase prices, shale companies have gained market share across different regions, even in Asia. Restraining production would cede market share to competitors. OPEC nevertheless continues to control the vast majority of the world’s low-cost production, and over the long run, could even disadvantage U.S. producers by manipulating supply levels.
No long-term strategy
OPEC officials speaking this week have made vague comments about the cartel’s plans for the remainder of the year and beyond. Exiting the current agreement, which cuts output by 1.8 Mbd, could create a sharp price drop. At the same time, continuing to restrict supply could cause the market to overshoot on the upside. Also under consideration is institutionalizing the current OPEC/non-OPEC group. One trader on Twitter opined: “Everything I hear from OPEC folks points toward the ‘muddle through and hope for the best’ option. They’ll extend the cuts forever and express their anger at shale from here.”
What is missing from OPEC’s strategy is longer-term growth to meet rising demand.
Just as critically, what is missing from OPEC’s strategy is longer-term growth to meet rising demand. Net additions from the cartel over the next five years are expected to total only 750,000 barrels per day (b/d), as losses in Venezuela offset growth elsewhere, particularly Iraq. The International Energy Agency (IEA) says although shale will dominate in the next few years, the modest OPEC growth will occur at the same time the demand for its crude will rise and shale increases will eventually slow.
At this time, the lack of investment in OPEC countries is worrisome. And OPEC knows that today’s current underinvestment could precipitate a supply gap and higher prices in the coming years. Barkindo said that current lower spending could cause problems over the longer term, and Saudi Aramco CEO Amin Nasser noted Tuesday at CERAWeek that the industry needs more than $20 trillion over the next two and a half decades to meet increasing oil and gas demand. This raises the question: Will OPEC producers fail to make the necessary long-term investments? Do uncertainty over shale and bullish forecasts for electric vehicles cloud their investment strategies, even if they realize that higher prices in the future are a stark possibility?
“There is a worldwide obsession with shale. It’s irrational exuberance in the U.S., and it’s irrational fear in the rest of the world.”
“There is a worldwide obsession with shale. It’s irrational exuberance in the U.S., and it’s irrational fear in the rest of the world,” Hess CEO John Hess said. If OPEC countries wait too long to make the necessary investments, it could take years before the needed supply comes online.
OPEC’s emphasis is on the short run, with its strategy of cutting output as part of the Vienna Group and talking to shale producers. It is clearly worried about its market sway, and formalizing its partnership with non-OPEC allies would give it broader influence. There’s no reason yet to think that the cartel is ready to pivot to thinking more about the longer run.