This article was published by The McAlvany Intelligence Advisor on Wednesday, October 14, 2015: 

Since early August the price of crude has jumped almost 20 percent, moving some, including those in OPEC’s cartel, to conclude that its strategy is working: Flood the market to force prices so low that marginal producers, especially in the United States, will go out of business. With the resultant decrease in supply, prices will rebound, hopefully to levels where the cartel’s countries can continue to fund their /warfare states.

Said the cartel last week: “This should reduce the excess supply in the market … resulting in more balanced oil market fundamentals.” Translation: we need higher prices and, by golly, our attack on marginal producers in the United States is working! Qatar’s Minister Mohammed Al Sada has concluded that the $38.50 price of crude reached in early August is the bottom, and it’s nowhere but up from here.

At first blush, it appears to be so. OPEC has estimated that U.S. oil production in 2016 will drop by nearly 300,000 barrels a day, to just 13.5 million bpd (including natural gas liquids), while the International Agency’s (IEA) estimate is similar. The industry’s rig count is down to lows not seen in years, and Mark Zandi expects job losses in the energy sector to continue at between 10,000 and 15,000 a month well into next year.

Digging into the numbers, however, reveals a much different story. Those marginal producers, and some of the majors, aren’t cutting indiscriminately. In fact, several of them are adjusting to the new reality by putting in place temporary hiring freezes, capping bonuses for the time being, and, in some cases, implementing across-the-board wage cuts. That way they are avoiding the “lost generation” of workers who were laid off in the late 1990s but never came back. As Dan Hill, the head of Texas A&M’s petroleum engineering department, explained:

Everybody who went through this before knows it really hurt oil companies … [for] not having a generation ready to move into management positions [when the industry recovered].

Occidental Petroleum, Canadian Natural Resources, and Continental Resources are keeping their most valuable workers in place, fully expecting the cutting and capping to be temporary.

OPEC is fighting a battle they, in the long run, cannot win. Fracking technologies continue to lower the cost of lifting a barrel of oil, and hence the break-even point, so that even small producers can develop, produce, and send to market a barrel of oil at a profit, even with prices at $40 a barrel or less. The rigs that have been stacked can be reset within months instead of years, and the most prescient among those producers are continuing to develop oil fields that they can bring online rapidly if prices rise.

Having perspective on the oil market is helpful here. World demand for oil and its derivatives has been steadily increasing for years, and is approaching 100 million barrels a day. OPEC provides about a third of that demand, while American producers about one-seventh of it. The balance is made up elsewhere, including Russia, Canada, and Venezuela. So when commentators warm of a “glut” of several hundred thousand barrels being stored in tanks or offshore in oil tankers, it’s almost a rounding error.

Cross-currents abound: the BRIC countries (Brazil, Russia, India and China) are struggling to keep their economies afloat, while in the United States early warning signs are showing up warning of a slowdown next year. On the other hand, Iran is already producing 2.9 million barrels a day, and could, if sanctions are lifted, possibly boost that number to 3.5 million by next summer.

In its report, the IEA gave itself plenty of wiggle room, noting that “the market may be off balance for a while longer, [but our] projected marked slowdown in demand growth next year, and the anticipated arrival of additional Iranian barrels … are likely to keep the market oversupplied through 2016.”

Unfortunately, OPEC needs higher prices now. Saudi Arabia is draining its foreign reserves at an unnerving rate, and is actually borrowing an estimated $4 billion a month just to keep its state afloat. Other cartel members are running deficits for every barrel they sell under $100 a barrel.

In the United States, however, such really don’t matter. Fracking technology, and painful past experience, is keeping the development business here prudent and profitable. If prices move higher, it will unleash its idle rigs and complete the development of many projects just waiting for the opportunity. If prices decline, it will continue to operate its most profitable projects.

It’s just a little bit early for OPEC and its various members to start claiming victory in its high-stakes game of chicken with the United States’ oil industry.


Wall Street Journal: Cutting Staff Pay to Keep Workers

Wall Street Journal: OPEC Sees U.S. Oil Output Dropping Next Year

Wall Street Journal: Oil Prices Volatile After IEA Warns Global Crude Glut Will Continue Into 2016 Oil futures slump to largest single-day drop since Sept. 1

3 month graph of NYMEX crude oil price

Bloomberg: Oil Glut to Stay in 2016 as IEA Sees Slower Demand Growth

World Crude Oil Consumption by Year

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