Shale Oil Gets Beat as OPEC Meets – 3/11/16

Shale oil and gas producers are facing increased political threats that add to low price woes. Meanwhile, OPEC members continue discussing possible output restrictions in cooperation with Russia.

Although Iran has stated that it will not take part in an oil production freeze, the Doha deal between Russia and Saudi Arabia appears to be gaining some support among other producers. No major producer is willing to institute reductions in output but a freeze is acceptable enough for many given that most are already producing near maximum levels. Of course, the refusal of Iran and Iraq to take part will make any agreement largely symbolic and Iran’s commitment to increasing production drives to 0% the chances of its rival, Saudi Arabia, reducing output. The two nations are the only large producers planning to increase output by a significant amount, while Saudi Arabian led cutbacks gave the OPEC cartel power over oil prices. A meeting in Russia is planned for March 20 that will likely cause more volatility in the oil market with little effect on the fundamental supply-demand mismatch.

Since sanctions against it were lifted in January, Iran has struggled to increase its oil exports as planned. Short-term obstacles like pipeline access, difficulty finding banks to process payments, reluctance of some investors to return to the country, and technical difficulties associated with restarting long unused facilities have made the goal putting an additional half million barrels of oil a day on the market seem overly optimistic. Still, those problems not likely to continue unless the reinstatement of sanctions seems likely and companies like General Electric Co. are already plotting courses into what appears to be a promising market.

Meanwhile, US shale oil and gas producers, whose rapid growth helped to create the current glut, are finally succumbing to low prices and high debt. After surprising analysts time and again with their resilience, shale drillers are starting to idle rigs in record numbers putting a sizable dent in production.

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Continued production decline has put output at its lowest level since 2014 putting into perspective not only how rapidly the tight oil industry has risen and fallen. And with the fortunes of the drillers go too the fortunes of supporting industries and towns. Pipeline partnerships are facing the same wave of bankruptcies as the drillers as investors lose faith in the once thriving area of the energy industry. All in all, the collapse in prices has proven brutal for those betting that the rise of tight oil would bring long-term prosperity and energy independence to the US. Unfortunately, tight oil will never as competitive as OPEC nations that can profitably pump even below $20 a barrel. That’s not to say that a revival in shale isn’t possible once prices improve even if that rebound might drive prices right back down again.

When it rains, it pours seems to fit the fracking industry’s problems. Between a heated legislative battle in Florida, weak demand leading to bulging inventories, limits on wells in Oklahoma prompted by linkages to earthquakes, and opposition by both presidential candidates and the sitting president, the future of fracking does not seem very promising. Given the current state of the GOP’s general election chances, the strong rhetoric offered up by Clinton and especially Sanders is putting fracking supporters in a state of panic. At the same time, the commitment of the Obama administration to cutting methane emissions, a main ingredient of natural gas often burned off or vented at oil wells, will put additional costs onto already unprofitable operations.

In the short run, shale oil will likely recover by 2018 as the most efficient drillers buy up the best assets of bankrupt rivals and global supply growth realigns with global demand growth. I say ‘likely’ because, besides the legislative threats mentioned earlier, there are plenty of technological threats that need to be accounted for. Electric and autonomous cars will be getting their own article but increased fuel efficiency and usage of renewable energy based heating systems also come to mind. In other words, I wouldn’t put money on another breakout performance.

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