U.S. Shale Tempers OPEC Deal Optimism – 12/28/16

After a period of low oil prices devastated its member nations, OPEC will start cutting collective oil output to 32.5 million b/d in January. With 11 non-OPEC producers reducing their own output by an additional 558,000 b/d, one might predict prices to rise fast and high. However, the threat of a revival in shale oil output from the U.S. is keeping a lid on expectations.

The main proponent of the group’s original pump-at-will policy that led to the glut, Saudi Arabia is now facing massive revenue shortfalls. The deal to cut global supply – if involved producers follow through on their promises – would probably give the largest OPEC producer a chance to catch its breath.

Saudi officials have justified their previous strategy using the decline in U.S. shale output, a major win in their fight to maintain market share. Yet, they may soon be faced with the harsh reality that shale is going anywhere. In its Short-Term Energy Outlook for December 2016, the EIA said that “oil production, particularly in the United States, has been more resilient in the current oil price environment than had been expected, as reflected in improving financial conditions at oil companies”.

And now that OPEC is expected to finally push for higher oil prices, the shale patch is benefit as much, if not more so, than OPEC members.

Oil rig counts from the U.S. have been steadily rising since the OPEC deal was announced. In 2016, the Permian basin play has seen acreage prices balloon despite crude oil prices remaining close to 50% of what they were 2014.

In late 2016, companies paid higher than $40,000 an acre for drilling leases, roughly eight times what similar leases sold for in 2014.

Still, there are some variables that could shock markets which are worth noting: Will OPEC stick to promised cuts? (probably not) Will those cuts rebalance the market at some point next year? (most would say yes) How fast will U.S. shale rebound when prices do go up? (almost certainly before the end of 2017)

The promise of production cuts has so far barely moved prices from the $50 per barrel mark, largely because the specter of shale production is keeping expectations in check. Oil price predictions coming from major analyst groups are generally in the $50-$60 range for 2017 and, no matter what spin people try to put on it, those are not good numbers for OPEC.

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