OPEC Flexes its Invisible Muscles
By: Kevin Burke
Following its highly anticipated meeting in Vienna on November 27, OPEC announced that it would maintain or ‘rollover’ its production ceiling of 30 million barrels per day. Leading up to this meeting there was a lot of heated debate among OPEC members about how to best respond to the recent drop in oil prices. OPEC’s poorer members such as Venezuela, Iran and Algeria wanted to cut production to reverse the rapid fall in prices. Ali bin Ibrahim al-Naimi, Saudi Arabia’s Minister of Petroleum & Natural Resources, and the most powerful voice within OPEC wasn’t willing to budge.
To truly understand the significance surrounding this event, it helps to look back about 10 years. In the mid 2000’s oil prices were rising sharply because global demand was surging, particularly due to large growth in China. Between 2011 and 2014 the price of oil has been hovering around $100 per barrel. With higher oil prices, many companies suddenly found it profitable to start extracting from difficult-to-drill places, using more costly extraction techniques. Major producing countries such as Canada, Russia and the United States have significantly increased their barrels per day production over the past 5 years. Putting emphasis on the US, techniques such as shale extraction, fracking and horizontal drilling has increased their crude barrels per day production from 5 million in 2008 to about 7.4 million in 2013 (global production is about 76 million barrels per day). If we look at total oil supply which includes crude, natural gas and other liquids the US has gone from 8.5 million barrels per day in 2008 to 12.3 million barrels per day in 2013 (global production is about 90 million barrels per day). This growth has continued throughout 2014.
For all intents and purposes, OPEC is now engaged in a price war with non-member producers, particularly US shale drillers. As the price per barrel of crude keeps falling, some US producers will likely become unprofitable and go out of business. The issue is that no one is quite sure how low prices need to go to curb the US shale boom. The consulting firm IHS has estimated that 80 percent of shale oil drilling in the United States would still be profitable at $70 per barrel and that the growth rate in shale oil output would decline at that price, but output would still be growing. The International Energy Agency indicates that a significant amount of US shale production remains profitable at or below $42 per barrel. Surprisingly, by maintaining production levels OPEC has abandoned its role as a swing producer. This leaves us with a good old fashioned standoff between supply and demand.
As of writing this, the January contract for WTI has sank to $66.15 per barrel, the lowest it has been since 2009. Upon leaving the November 27th meeting, OPEC Secretary-General Abdalla El-Badri was quoted saying “We will produce 30 million barrels a day for the next six months, and we will watch to see how the market behaves”. Some have called this the most significant economic event of 2014, and it should make for some interesting months ahead. Although we will be seeing a lot of smiles on Canadians’ faces at the pumps, this does not bode well for many Canadian producers, our friends out in Alberta and our economy as a whole.