OPEC vs. Shale: The stakes are raised

Last week’s OPEC meeting could be construed as heralding the beginning of the end of Middle Eastern oil exporting dominance. As Assistant Editor of the Daily Telegraph Jeremy Warner suggested, low oil prices are a reflection of the extraordinary lengths the cartel is going to try and retain its grip on a market it looks increasingly nervous about losing a sizeable share of. It is, he suggests, a reflection of the cartel’s diminished power.

The real picture, however, is not nearly as straightforward. The decision by OPEC not to cut production is of course undoubtedly motivated by a desire to retain market share against its upstart competitor in the form of North American shale.

But will it work?

While oil has dropped to price lows that make it a far more palatable option for consumers then shale, this does not necessarily mean it will diminish shale production in the short term. As the IEA’s latest energy report highlighted, lower prices will slow down investment in the shale industry, but shale production is initially likely to adjust to meet market price trends as producers enhance efficiency and cut costs in the extraction process to maintain competitiveness. However, low oil prices and the comparatively swifter rate of shale depletion (the IEA expects tight oil output to level off in the 2020s) means at some point shale production will indeed become unprofitable should the current circumstances persist, leading to an inevitable dip in production. It is after this point that oil prices may begin to rise again as oversupply in the U.S. will begin to self-regulate.

For OPEC, the challenge lies in ensuring discipline amongst members

Vicente Lopez-Ibor Mayor

It is a realisation that appears to have had an effect on shale companies already. Many have announced they are reassessing their drilling programmes and implementing cuts across the board to enhance efficiency. There were also 1,568 drilling rigs for shale extraction in the U.S. in mid-November, 41 fewer than in mid-October, a substantial drop for a single month and a trajectory likely to continue in coming months.

What’s more, much of the shale boom owes its success to significant Wall Street investments and debts. Should this investment decline, companies will struggle to continue production simply due to the huge up-front costs required to extract shale. Even before the drop in prices, shale companies operated with huge debt and even banker driven bailouts and bankruptcies. At some point banks and investors will have no choice but to call a halt to negative cash flows and it is after this that the production outlook of shale will change dramatically.

New export policies

To alleviate some of the pressure on the shale industry, the soon-to-be Republican-controlled Congress is likely enact new export policies allowing U.S. producers to export oil and Liquefied natural Gas. U.S. producers will find it cheaper and more lucrative to export shale then to compete with the oversupply of oil domestically within the U.S. market, thereby strengthening the power of shale energy to compete on a more global scale.

However, as OPEC secretary general Abdullah al-Badri put it, the big issue comes back to price and cost of production; "If prices stay at $85, we will see a lot of investment, a lot of oil, going out of the market, about 65 percent of the producers, they have high costs. Not OPEC." His comments indicate OPEC sees the shale industry’s lack of long-term competitiveness (or lack of) in the face of the current price squeeze as something that will end up regulating oil prices.

For OPEC, the challenge lies in ensuring discipline amongst members; something that won’t be easy given it is only Saudi Arabia that can sustain itself on the current price lows. For the U.S. the big lesson is that energy independence is not synonymous with finding increasing ways of harnessing energy domestically. Energy consumption takes places within a free market paradigm. In the context of a globalised market, it is the Saudis that still pull the strings on pricing and therefore, on the economic viability of other alternative energy forms, including its more expensive rival, shale.
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Vicente Lopez-Ibor Mayor is former Commissioner of the National Energy Commission of Spain. He is Chair of one of Europe’s largest solar energy power companies, Lightsource Renewable Energy Ltd. Vicente is also Member of the Eminent Persons Group on the “Atlantic Basin Initiative” of the Transatlantic Initiative of the Johns Hopkins University and President of the Spanish-North American Association, VIA-Jefferson Circle of Spain. He has previously written for the Financial Times UK and Bloomberg amongst others and is author of the book ‘Energy & Society’.

 

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