Shale vs OPEC: What’s going on with oil prices? Will the bleeding stop, and when?

January 13, 2015 |

liquid fuels balance 011315 smWill oil prices ever stop falling, and who’ll be left standing when they do?

How long can the war of attrition gone on between North American shale producers and OPEC?

Oil prices are falling — fast. Nothing seems to stop the slide. Increasingly, it can be seen as a battle over market share as a normal cyclical downturn in demand (EU and China based, mostly) turned into a battle between producers over where production cutbacks were going to come from, as the inventories pile up.

What’s going on?

UAE energy minister Suhail bin Mohammed al-Mazroui said today: “The strategy will not change.” Pressed to give a bottom price, he commented:

“I’m not going to give you a price but I would suggest something we all know, that the shale oil producers are very important for the market supply and we all need them to stay. So if that is the case, since they are producing almost 4 million (barrels per day) today, I think whatever price that makes shale oil continue to be produced is going to be the fair price for the conventional producers to produce, whether 60 or 70 or 80 (dollars) or whatever figure – that is where the market will stabilize.”

Saudi billionaire businessman Prince Alwaleed bin Talal told USA Today:

“We have an oversupply. Iraq right now is producing very much. Even in Libya, where they have civil war, they are still producing. The U.S. is now producing shale oil and gas. So, there’s oversupply in the market.

“But also demand is weak. We all know Japan is hovering around 0% growth. China said that they’ll grow 6% or 7%. India’s growth has been cut in half. Germany acknowledged just two months ago they will cut the growth potential from 2% to 1%. There’s less demand, and there’s oversupply. And both are recipes for a crash in oil. And that’s what happened. It’s a no-brainer.”

Here’s what’s going on, as illustrated in this EIA chart, which shows the imbalance between increases in demand and the increases in non-OPEC production. In short, non-OPEC oil is being dumped on the market faster than rising demand can catch up with it:

consumption and non-OPEC production 011315

And we also see in this EIA chart that the US and Canada are the culprits in significantly increasing supply to the market, and mostly US.

crude oil growth 011315

Meanwhile, demand is certainly growing, but interestingly energy stocks, while growing, are not exactly soaring.

liquid fuels balance 011315

The US-Saudi competition for market share

One of the dynamic stories of the year is competition between the US and Saudi Arabia for market share in global oil production. First, there’s the narrowing gap in terms of crude oil production, as seen here:

US Saudi crude 011315

 

But, let’s consider also the “total oil” picture, in which we also consider the impact of natural gas as an oil substitute, and biofuels. Taking thos into account, the US has already passed Saudi Arabia, as seen here.

US-Saudi total 011315

What will happen? Will prices continue to fall?

The Energy Information Administration, in its Short-Term Energy Outlook, released today, opined:

December was the sixth consecutive month in which monthly average Brent prices decreased, falling $17/barrel (bbl) from November to a monthly average of $62/bbl, the lowest since May 2009. The December price decline reflects continued growth in U.S. tight oil production, strong global supply, and weakening outlooks for the global economy and oil demand growth.

EIA forecasts that Brent crude oil prices will average $58/bbl in 2015 and $75/bbl in 2016, with annual average West Texas Intermediate (WTI) prices expected to be $3/bbl to $4/bbl below Brent. The current values of futures and options contracts suggest very high uncertainty in the price outlook (Market Prices and Uncertainty Report).

WTI futures contracts for April 2015 delivery, traded during the five-day period ending January 8, averaged $51/bbl, establishing the lower and upper limits of the 95% confidence interval for the market’s expectations of monthly average WTI prices in April 2015 at $34/bbl and $76/bbl, respectively. The 95% confidence interval for market expectations widens considerably over time, with lower and upper limits of $28 and $112 for prices in December 2015.

Again, as Prince Alwaleed bin Talal told USA Today: If supply stays where it is, and demand remains weak, you better believe it is gonna go down more. But if some supply is taken off the market, and there’s some growth in demand, prices may go up. But I’m sure we’re never going to see $100 anymore. I said a year ago, the price of oil above $100 is artificial. It’s not correct. Although Saudi Arabia and OPEC countries did not engineer the reduction in the price of oil, there’s a positive side effect, whereby at a certain price, we will see how many shale oil production companies run out of business. So although we are caught off guard by this, we are capitalizing on this matter whereby we’ll live with $50 temporarily, to see how much new supply there will be, because this will render many new projects economically unfeasible.

Overall, the futures market tells us that prices are going up, but recovery will be slow if this look at WTI futures is accurate:

oil prices forward 011315

The forward market for oil

The US Energy Information Administration says, “expects global consumption to grow by 1.0 million bbl/d in 2014 and 0.9 million bbl/d in 2015…Compared with last month’s forecast, global consumption was revised downward by 0.2 million bbl/d in 2015, based on a 0.3% reduction to forecast global oil-consumption-weighted real GDP growth. In the short term, the income elasticity of global demand is greater than the price elasticity of global demand.

The demand is coming from outside of the OECD, or the developed nations

EIA writes: “Consumption outside of the Organization for Economic Cooperation and Development (OECD) is projected to grow by 1.2 million bbl/d in 2014 and 0.9 million bbl/d in 2015. China is the leading contributor to projected global consumption growth, with consumption increasing by an annual average of 0.36 million bbl/d in 2014 and 2015.”

Price volatility and uncertainty

The EIA warns that “the current values of futures and options contracts suggest high uncertainty in the price outlook,” noting that “WTI futures contracts for March 2015 delivery…averaged $67/bbl, with “lower and upper limits of the 95% confidence interval for the market’s expectations of monthly average WTI prices in March 2015 at $51/bbl and $89/bbl, respectively.”

Factors to consider: the global economic growth outlook

Today, the World Bank cut its growth forecast for 2015 and 2016, writing:

Global growth in 2014 was lower than initially expected, continuing a pattern of disappointing outturns over the past several years. Growth picked up only marginally in 2014, to 2.6 percent, from 2.5 percent in 2013. Beneath these headline numbers, increasingly divergent trends are at work in major economies.

While activity in the United States and the United Kingdom has gathered momentum as labor markets heal and monetary policy remains extremely accommodative, the recovery has been sputtering in the Euro Area and Japan as legacies of the financial crisis linger, intertwined with structural bottlenecks. China, meanwhile, is undergoing a carefully managed slowdown. Disappointing growth in other developing countries in 2014 reflected weak external demand, but also domestic policy tightening, political uncertainties and supply-side constraints.

Several major forces are driving the global outlook: soft commodity prices; persistently low interest rates but increasingly divergent monetary policies across major economies; and weak world trade. In particular, the sharp decline in oil prices since mid-2014 will support global activity and help offset some of the headwinds to growth in oil-importing developing economies. However, it will dampen growth prospects for oil-exporting countries, with significant regional repercussions.

Overall, global growth is expected to rise moderately, to 3.0 percent in 2015, and average about 3.3 percent through 2017. High-income countries are likely to see growth of 2.2 percent in 2015-17, up from 1.8 percent in 2014. In developing countries, as the domestic headwinds that held back growth in 2014 ease and the recovery in high-income countries slowly strengthens, growth is projected to gradually accelerate, rising from 4.4 percent in 2014 to 4.8 percent in 2015 and 5.4 percent by 2017. Lower oil prices will contribute to diverging prospects for oil-exporting and -importing countries, particularly in 2015.

Factors to consider: The Euro and stimulus

One of the factors in the world oil price equation right now is the falling Euro. Ordinarily, when prices fall, demand rises — but that effect has been dampened because the Euro has been in freefall all year. With oil prices dollarized, that means that European markets aren’t seeing the full impact of chewaper oil.

It could get worse, the Wall Street Journal reports: “The euro is likely to drop to parity with the dollar by the end of 2016 and could fall to 90 cents by the end of the following year,” in a research note by GS’ Robin Brooks, Fiona Lake and Michael Cahill.

Let’s illustrate.

Brent-EUR-USD

Bottom line, if Goldman Sachs is right, the EU could be looking at an oil price increase in local currency, compared to a 32 percent drop in the actual oil price.

What may change that is an EU stimulus. “There’s a struggle right now between ECB President Mario Draghi, who is pushing for a stimulus, and Angela Merkel of Germany, who is worried about having inflation,” says Prince Alwaleed bin Talal.We’re seeing a clash over there between these two ideas. But I think that Draghi is preparing the market for a stimulus. Yes.”

The Bottom Line

Currencies and the state of economic growth are playing a role in depressing demand, rampant growth in North American production has meanwhile set off a market share battle between the US and Saudi Arabia. Given that US investments have much higher break-even points, it is a question of whether OPEC’s tolerance of the loss of oil income (the social factor) is greater than investor tolerance of losses, as shale oil ventures fall into negative margin territory.

Imagine, if you will, a sort of reversal of the kind o protests and unhappiness we see with high energy prices — generally directed at the Middle East. In this case, consumer unrest might flow out of the Middle East. Prompting a social upheaval that may not well be popular within diplomatic circles.

Here in Digestville, we wonder if all the social risks are priced into oil right now — leading us to suggest that year-end prices might be higher than currently suspected. But we’ll all see if OPEC nations can keep a lid on unhappy consumers in the Middle East looking at reduced national social spending, or massive budget deficits and the threat of spiraling inflation.

For biofuels, we’ll look at the impact today here, in terms of companies that have break-even points well suited to current prices. We also continue to point to (with low prices) market conditions favorable to expanded demand for gasoline, which will help the ethanol market.

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