ANALYSIS: US Fracking Is Ascendant, But OPEC Isn’t Dead Yet

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Michael Bastasch Energy Editor
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OPEC member states and Russia will meet in Vienna Thursday, where they are expected to agree on continuing oil production cuts for another nine months.

The petro states are seeking to keep crude oil prices from sliding below $50 a barrel. OPEC, Russia and 10 other non-member states agreed to reduce output by 1.8 million barrels per day in the first half of 2017.

OPEC’s Thursday meeting, however, highlights the fundamental shift occurring in the global oil industry.

“This is a structural change that’s unprecedented,” Mark Mills, an energy economist at the right-leaning Manhattan Institute, told The Daily Caller News Foundation.

“There hasn’t been a structural change in oil markets in 40 years,” Mills said, adding that “shale changed everything.”

An industry that for decades was dominated by a handful of multinational corporations and state-owned oil companies is increasingly being disrupted by thousands of smaller companies and investors.

Those small players control thousands of wells that cheaply extract oil and gas from shale formations across the U.S. using hydraulic fracturing, or fracking.

Mills said that while “you can’t say OPEC is dead,” U.S. oil producers are poised to scale up their share of the global oil market. If the U.S. made up 20 percent of the global oil market, it would be “a geopolitical tsunami,” Mills said.

At the end of the day, U.S. shale will likely continue to gain on OPEC production, keeping a lid on oil prices. But that doesn’t mean OPEC will be put out of business for good.

“Shale markets cannot supply the world — even if shale production doubles,” Mills said. “If you’re an OPEC member and all you have to sell is oil, you’ll sell oil.”

OPEC Isn’t Out Yet

OPEC leader Saudi Arabia embarked on an expensive experiment to see just how resilient U.S. oil production would be to low oil prices.

The Saudis refused to re-balance oil markets in the summer of 2014, leading to a crash in crude prices. Crude went from around $114 per barrel a in summer 2014 to $30 a barrel in early 2016.

U.S. production did suffer. Domestic oil producers laid off thousands of workers as output shrank, but not as much as the Saudis maybe anticipated.

What the Saudis found out, however, was that U.S. shale producers increased output for a time as prices plunged. Now, with crude prices around $50 a barrel, shale drillers are ramping up production even more.

U.S. oil production hit a low of 8.6 million barrels per day in April 2016, but has since rebounded as crude prices rose to about 9.2 million barrels a day.

Analysts expect U.S. production to hit 9.7 million barrels a day by the end of 2017, and production could increase even further. The Permian Basin’s output alone could exceed 3 million barrels a day in the coming years, according to the Federal Reserve Bank of Dallas.

OPEC members, on the other hand, took a big hit. The International Monetary Fund (IMF) estimated Middle Eastern producers lost nearly $400 billion in oil export revenues in 2015.

In 2016, OPEC members lost $76 billion in export revenues. Saudi Arabia had to burn through its currency reserves, and OPEC members facing higher production costs successfully pressured the Kingdom to agree to oil production cuts in December 2016.

“I think the Saudis understand what’s going on,” Mills said.

Mills wasn’t surprised at the resiliency of U.S. fracking operations. The fracking boom started when crude was around $50 a barrel. Rising oil prices through 2014 were just icing on the cake for frackers.

The Saudis know they no longer exert the same control over oil prices as they used to, so they want prices to rise to a place where they are comfortable. The Saudis can make money with oil around $50 a barrel.

“They’re just making the calculation it’s better to sell at a higher price than sell more at a lower price,” Mills said.

“They can do fine in the fifties, they can make money in the fifties,” Mills said, “shale can too.”

Saudi Arabia is also making a huge effort to diversify its economy away from oil exports, but don’t expect the Kingdom or many other OPEC members to ditch oil anytime soon.

What To Expect This Week

Both Saudi Arabia and Russia announced in May they would support a decision to extend production cuts another nine months, pushing cuts into 2018.

The Russians and Saudis want to keep crude prices above $50 per barrel — at that price many petro states would be able to recover some of their export revenue losses.

So, what does that mean for oil markets?

“The deal on crude production cut taken in late 2016 will be prolonged,” Igor Yusufov, Russia’s former energy minister, said in an email to TheDCNF.

Yusufov said oil price stability in the mid-term, however, will depend on U.S. oil production. OPEC and Russia may continue production cuts, but analysts expect U.S. fracking to produce more oil as prices rise.

“All achievements of markets stability will be dependent from the readiness of the Trump administration to initiate a dialogue with other crude producers,” said Yusufov, who used to represent Russia at OPEC meetings.

“The recent successful visit of President Trump to Saudi Arabia could be seen as the first move to this direction,” Yusufov said. “As for non-OPEC nations, Russia could be an appropriate counterpart in talks on further oil market stability.”

Some media outlets have pointed to President Donald Trump’s proposal to sell off 270 million barrels of oil from the U.S. Strategic Petroleum Reserve, suggesting it could put a damper on OPEC’s bid to raise prices.

Experts say an SPR release is unlikely to have much of an impact on prices.

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