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June 8, 2015

OPEC On A Long Game of Oil Price War

OPEC decided not to cut production at its June 5, 2015 meeting in Vienna. So, oil prices should continue the descent that began in early May (Figure 1). Prices may fall into the $50+ per barrel range since there is no tangible reason for their rise from January’s $46 low. 

Figure 1. Brent crude oil spot price May 1- June 1, 2015: Source: EIA and Labyrinth Consulting Services, Inc.

It is remotely possible that OPEC may decide to cut production because many members are strapped for cash but I suspect that Saudi Arabia’s longer view of demand and market share will dominate the decision and that there will be no cut.

World oil production has undergone a structural shift from supply dominated by relatively inexpensive conventional production to increasingly more supply coming from expensive deep-water and unconventional production. Most conventional oil will be increasingly focused in the Arabian, Siberian and North Caspian basins (Figure 2) while deep-water and unconventional production is focused along the margins of the Atlantic Ocean and in North America.

Figure 2. Location map showing Arabian, Siberian and North Caspian sedimentary basins. Source: USGS.

This shift is at the root of the current price conflict between OPEC and North American oil producers. Since 2008, OPEC liquids production has been fairly flat until mid-2014 (Figure 3). Non-OPEC production outside of North America has been flat. Most production growth has occurred in the U.S. and Canada but it is not only from tight oil.

Figure 3. World liquids production since 2008 showing OPEC, non-OPEC minus the U.S. and Canada, and the U.S. and Canada. Source: EIA and Labyrinth Consulting Services, Inc.

The competition for OPEC market share is from Canadian oil sands, Gulf of Mexico deep-water and tight oil production. U.S. plus Canadian production has increased 6.2 million barrels per day (mmbpd) since January 2008. OPEC production has increased 2 mmbpd over that period with 1.3 mmbpd (65%) of that increase since June 2014.

Lower oil prices over the past year (Figure 4) have not resulted yet in any observable decrease in North American production. Higher prices over the last few months further complicate the situation for OPEC. The global production surplus has gotten worse, not better, in recent months but prices rose based on sentiment.

Figure 4. Crude oil prices since June 2014. Source: EIA and Labyrinth Consulting Services, Inc.

It is true that U.S. production may be falling but a 3-month lag in reporting prevents us from seeing this. It is also true that OPEC may have limited capacity to increase their production further although Middle East rig counts have never been higher.

The only way for OPEC to significantly increase its market share is to undermine North American expensive oil production with low oil prices for at least another 6 months.  That is why a production cut at this time is not in the cards for OPEC.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle
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