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The OPEC “Deal”: What It Really Means

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By John Richardson on 29-Sep-2016

By John Richardson

EIATHE OPEC decision to cut oil production for the first time since 2008, if indeed it does amount to a real cut in production, could end up being self-defeating.

As I discussed last month, US shale oil production efficiency continues to go quite literally through the roof of most forecasters expectations. Between January 2007 and October of this year, the  Eagle Ford shale-oil field in Texas will have seen the efficiency of oil output from reach of its rigs increase by 2,700%. The Bakken field in North Dakota is meanwhile set to see its oil output per rig jump by 730%.

Sure enough, therefore, as breakeven costs of production continue to fall output is rising. Earlier this week, before the rally in oil prices resulting from the OPEC announcement, Goldman Sachs was forecasting that the US will be pumping an additional 600,000 to 700,000 bbb/day by the end of next year.

And confirming my analysis from October 2014, access to capital is not a problem for the US shale-oil industry. As the same article from the Wall Street Journal newspaper, which I have just linked to above also points out:

Even as banks and other traditional lenders tighten their purse strings, alternative sources of money are cropping up, from private equity funds to distressed debt specialists.


Putting the production cut into the proper perspective

Let’s look at the numbers first of all, based on Reuters reporting of the outcome of the Algeria meeting:

  • OPEC members would limit production to a range of 32.5m-33m bbl/day down slightly on August’s output of 33.2m bbl/day.

Clearly not enough if I am right about the rise in US production. And of course the longer that the post-OPEC meeting lasts, the more likely it is we will see an increase in that Goldman estimate of an extra 600-700m bbl/day of US production by the end of next year.

This is assuming that this is actually a production cut in the first place. As the Wall Street Journal also reports:

Saudi Arabia, OPEC’s biggest producer, typically pumps more oil in the summer to meet domestic demand and less in the winter. OPEC officials could be referring to the expected seasonal decline in Saudi production when they talk about an output cut, analysts say.

Add to that the difficulty of getting OPEC members, never mind non-OPEC members, to put an agreed production cut into effect and your scepticism has to further increase.

Crucially, also, there is the role of OPEC member Iran in all of this. It is Iran’s intention to raise its output from 3.6m bbl/day, unchanged since the easing of sanctions, to 4m bbl/day.

It is hard to see why it wouldn’t go ahead with this increase as soon as it can attract the necessary foreign investment in its oil fields. Iran has a lot of lost economic ground to make up, and the surest way of it making up some of this ground is to gain more market share in the global oil market.


The Fundamentals Remain the Same

An OPEC deal, or non-deal, doesn’t change the long-term shift in the fundamentals of the oil market. You cannot afford to be distracted from the following three things:

  1. It is the demand for oil that is also a key issue here now that the Economic Supercycle is over. Ageing populations in the West and China’s search for a new, more sustainable economic growth model are both resulting in lower consumption growth.
  2. Last year’s Cop 21 agreement in Paris underlined the permanent shift in global thinking on climate change. Fuel efficiency will thus increase, along with the shift to renewables and other alternatives, such as battery-powered cars.
  3. OPEC has understood both the above for a long time, and so realises that it needs to pump as much oil as possible whilst it can, rather than risk leaving oil in the ground.
  4. And in the case specifically of Saudi Arabia, its Vision 2030 initiative is about moving away from a too-heavy reliance on directly exporting oil as a driver of its economic growth. So this will mean more downstream investments in refining and petrochemicals, even at the expense of supplying these investments with cheap hydrocarbon feedstocks. Vision 2030 is about economic diversification and with it three more crucial things for Saudi Arabia’s very youthful population: Jobs, jobs and more jobs.