What a strange feeling to be talking about good old energy markets again, after months lost in the advocacy wilderness (Canadian Energy Centre, if this is your idea of help, please go wait quietly in the cigar lounge with all the others from whom we expect more, and you know who you are). The mind-bending challenge of trying to defend Canada’s place as a worthy supplier of the energy the world needs and demands against people that don’t understand that is overwhelming. It is, therefore, a relief to be able to talk about the reality of markets again.
OK then, what do we have going on in the oil markets… Oh for crying out loud, this is worse than the climate wars. Well, not quite. This world is transparent, the political motivations are as obvious as a facial tattoo, and the players understand clearly the ramifications of what they’re doing. But still, a market meltdown like this is about the last thing battle-weary producers need.
What’s been happening in the past few days is an almighty game of economic chicken. Saudi Arabia/OPEC wanted to moderate production to keep prices in a comfortable not-too-hot-not-too-cold range, and a bid for this sort of price stability makes sense in a world dealing with a possible pandemic and corresponding potential oil demand destruction. Russia refused to play along, however, musing to reporters that they might actually increase production. Within a day or two, Saudi Arabia announced that they were not just considering raising production, they were going to raise production, and were slashing prices. And here we go, back twenty years to when these skirmishes were a regular sport.
The first observation is for those who in the past few years have declared OPEC obsolete, and the US the world’s new “swing producer”. Wrong. Those observers mistakenly equate growing US production with obliteration of OPEC, and with swing producer status.
OPEC may not be the organization it once was, because their share of global supplies has shrunk and/or member states don’t have the flexibility to curtail production the way a good old cartel requires (meaning, they’re living paycheque to paycheque and not rolling in oil wealth). That doesn’t mean however that OPEC is dead (although OPEC+ may be dead). OPEC, if only through Saudi Arabia, still has the ability to curtail production to achieve pricing objectives. Therefore, OPEC still has power. They may not have the power to lift prices to $100+/barrel for a sustained period, but that doesn’t mean they don’t have power. They have the ability, as we most likely will see soon, to drive prices to very low levels, and also to much higher levels.
And that brings us to the US “swing producer” misconception. A true swing producer increases or decreases production to keep prices in a preferred range (or for other political reasons). The distinction is that they adjust production for reasons other than, say, the pure economics of drilling a well at strip prices.
US production, specifically US shale production, is more akin to the cockroach in the movie Wall-E. Nothing can kill it. Low oil prices slow growth a bit, rising prices speed it up, but there isn’t the slightest hint of anything other than pedal-to-the-metal behaviour. Producers do the opposite of swing-producer behaviour; they drill longer and longer wells, chewing up sweet spots ever-faster, simply in an effort to drive well costs down. There’s nothing wrong with lowering well costs, but when it’s done by devouring the best acreage at ever-lower prices, it’s not going to end well. Consider two mega-fields for example; Saudi Arabia’s Ghawar began production 70 years ago and through careful management, precise mapping, and a view to longevity, still remains globally very important. The Permian shale may be peaking already, and there isn’t a hint of a long term maximization plan.
And that note brings us to the most interesting speculation about the whole Saudi-Russia oil price dance. Is this engineered price crash a concerted attempt to crush US shale output growth in a meaningful way? To date, lower prices haven’t much slowed the juggernaut, which is leading many to speculate that the Saudi-Russia axis has had enough of waiting patiently for the US-shale-supernova to flame out by taking some drastic action. And as of writing, good heavens, the reaction is certainly drastic.
With access to capital markets limited, anti-fossil fuel investment sentimentality on the rise, and increasing opposition to US petroleum development, not to mention dwindling sweet-spot locations and parent-child interference, the US shale industry does appear to be one battered warrior. But we’ve thought it down for the count before, only to see it rise again. This would make a great movie, the US superhero against the Arab and Russian global dominators. But will the US shale superhero be played by Dwayne Johnson or Danny DeVito? Time will tell.
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Read more insightful analysis from Terry Etam here, or email Terry here.