US FRACKERS ARE THE SKUNKS AT THE PUTIN-OPEC GARDEN PARTY
The OPEC cartel is to forge a permanent alliance with a Russia-led bloc of producers by the end of the year, aiming to regain control of the world crude market with a super-combine of unprecedented scale and reach.
Suhail al-Mazroui, OPEC’s president, said the two groups are working on a “framework partnership” that would tie them together closely in perpetuity after their current deal to cap production jointly expires later this year.
“We have built up enormous trust,” he told the International Petroleum Week forum being held in London now (2/20-22), an annual gathering of the world’s oil and gas elites.
Mr. al-Mazroui, who doubles as the United Arab Emirates’ energy minister, said the broad “ROPEC” alliance has exceeded the agreed cuts of 1.8m barrels a day (b/d) with a compliance rate of 107%. This spiked to 133% in January as Saudi Arabia throttled back production in a bid to clear the global glut of crude, hoping to stabilize prices before the kingdom floats a share of the state oil giant Aramco.
The new super-cartel would once have been a radical development for the oil industry. Today it’s an awkward and belated response to the threat of America’s “short-cycle” shale frackers, who can respond with lightning speed and are preventing the normal cycle of full recovery from taking hold.
The fracking industry seized on the “ROPEC” cuts to ramp up US output by over 250,000 b/d a month over the winter, with a further 1.3m b/d expected this year.
The International Energy Agency says exploding US production in 2018 may match the entire growth in oil demand from China and the rest of the world, potentially causing the latest rally to short-circuit before prices durably surpass $70. It expects the US to leap frog past Saudi Arabia and Russia to become the world’s biggest producer this year, eyeing a record 11m b/d.
Dan Brouillette, the US Deputy Energy Secretary, told the IP forum that the US is on the brink of world “energy dominance” as it becomes a net exporter of fossil fuels, transforming the strategic balance of power. He predicted a “phenomenal” rise in US oil output this year and next. “I don’t see it as a blip,” he told Bloomberg (2/20).
The OPEC-Russia alliance faces a grim dilemma as US frackers keep gobbling up the windfall of rising world demand. The super-cartel may face a choice of extending its production caps into 2019 and ceding ever greater market share to North America, or reverting to the price war of 2016 and precipitating a fresh market collapse.
A price war is a blunt double-edged weapon. US frackers have sold forward much of their production through hedge contracts and can withstand a long siege. It would lead to a fresh squeeze on OPEC government revenues and foreign exchange reserves.
The OPEC cartel is betting that output of US “tight oil” will peak at 12.4m b/d in 2025, arguing that frackers are fast exhausting the best Tier I and Tier II “shale plays” and cannot keep replacing them with fresh fields.
Events will determine whether this is more of the same wishful thinking that has long bedeviled OPEC analysis. The cartel misjudged the shale phenomenon from the outset – unlike Russia’s Vladimir Putin, who spotted the danger early – and kept prices too high for too long.
OPEC was convinced that the oil price crash in 2015 and 2016 would bankrupt swathes of the shale industry and halt the US juggernaut.
This was a bizarre misunderstanding. Firms were driven out of business but their assets were snapped up by private equity groups or other drillers with deeper pockets. There was no lasting impact on the shale revolution. The industry became more efficient precisely because it was able to clear aggregate debt under US Chapter 11 laws.
A shale crisis is even less likely to happen a second time since banks and investors have since imposed stricter discipline. “The survivors of the last cycle learned the lesson. Shale producers have a much more effective hedge program today,” said Thomas Petrie, a shale veteran at Petrie Partners.
Bob Dudley, chief executive of BP, said the global oil industry will have to get used to hard grind of “lower for longer”, warning investors not to be “fooled” by the latest price rally. “We all began to think that $100 was normal. It has been a very painful restructuring,” he said.
The major oil companies can flourish in the new order. They can make just as much profit today with prices at $60 as they could at the peak of the last boom, thanks to vaulting gains in productivity from digital technology. “We’re doing a lot more work, with a lot less people, and lot less capital,” Dudley told IP.
The real losers are the rentier petro-states that rely on bumper revenues from oil exports to pay for cradle-to-grave welfare systems and to keep the lid on civic protest. Their political model is essentially broken.
In the end, a series of powerful forces will combine to create a fresh oil spike. New crude discoveries have fallen to the lowest since the Forties; investment in upstream oil and gas exploration has dropped by 40%; existing fields are declining at a rate of 5%; the world’s fuel-hungry middle class will expand from three billion to five billion over the next quarter century.
It is a formula for the next perfect storm. But the OPEC-Russia “ROPEC” alliance may have to wait far longer than it ever imagined for the long cycle to turn.
Ambrose Evans-Pritchard is the International Business Editor of the London Telegraph.