Analysis: The Future Of OPEC And Oil Prices
The Organization of the Oil Exporting Countries (OPEC) was born in a time of plenty, prospered over a period of real or perceived scarcity, and will likely die in the distant future as the world shifts away from high-carbon energy resources.
In the interim, OPEC, and its newfound non-OPEC friends — especially Russia — will have their work cut out for them. They should have the wherewithal to keep crude oil prices at a fairly high level until the U.S. light tight oil (LTO) revolution meets a significant slowdown in global oil consumption growth in the first half of next decade, but as the LTO revolution spreads beyond the U.S. and oil consumption plateaus and then declines “OPEC Plus” will be forced to gradually ratchet down their target price until it is no longer economically worthwhile to control oil supply.
OPEC accomplished little in its first decade of existence, but as the global oil market began to tighten in the early 1970s, the power differential between oil importing and exporting countries flipped, allowing OPEC members to nationalize the producing assets of the international oil companies in their countries and allow OPEC to gain control of crude oil production and capacity decisions — and to a degree crude oil prices.
Over the next 40 years, OPEC as a rule has been able to keep benchmark light crude prices above US$45 per barrel in inflation adjusted terms — the average price since the beginning of the oil industry in the late 19th Century — with little or no help from major oil exporting countries outside of the organization. This changed forever in the middle of this decade, with the U.S. LTO revolution hitting in earnest.
Saudi-led OPEC attempted to break the back of the U.S. LTO revolution with the 2014-16 oil price war, the most prolonged in the organization’s history, but failed miserably. The U.S. industry has rebounded leaner and meaner than few experts believed possible, with U.S. crude oil production increasing 470,000 bpd to 9.33 million bpd in 2017 despite WTI averaging only around US$50 per barrel and the International Energy Agency (IEA) recently warning of potentially “explosive” growth this year if Brent crude remains around US$70 per barrel — equivalent to roughly US$65 WTI. Prior to the price war, the average breakeven price for U.S. LTO was widely believed to be around US$80 per barrel.
In their 2014 book “The Second Machine Age,” MIT professors Erik Brynjolfsson and Andrew McAfee convincingly argued that we are at a second inflection point in terms of human progress that is supercharging technological advancement and innovation already propelled by the Industrial Revolution, leading to even greater productivity improvements than in the past. They wrote: “Now comes the second machine age. Computers and other digital advances are doing for mental power — the ability to use our brains to understand and shape our environment — what the steam engine and its descendants did for muscle power. They're allowing us to blow past previous limitations and taking us into new territory.”
Improvements in LTO rig productivity have been truly second machine age-like for most of the past decade — as have improvements in battery and other technologies hastening the day that global oil consumption peaks — gradually bringing down breakeven prices for U.S. LTO even before the 2014 crude price collapse, despite skyrocketing activity in the industry, and should more than counter rising cyclical costs in the patch moving forward. For example, the average monthly growth rate in oil production per rig in U.S. LTO basins was 2.2 per cent between January 2007 and January 2018 — increasing production per rig from a mere 36 bpd to 639 bpd — with the only prolonged productivity decline from September 2016 to May 2017 as drilling activity in U.S. LTO basins more than doubled in this short period.
The IEA finally saw the light and became relatively bullish U.S. oil production in November with the release of World Energy Outlook 2017. Based on projections in its New Policies Scenario, U.S. oil production — including NGLs — should increase 4.4 million bpd to 16.9 million bpd between 2016 and 2025, hogging 80 per cent of global oil production growth and making the U.S. the largest oil producer in the world. As more digitized drilling information becomes available we are seeing an expansion of overall technically recoverable resource and sweet spots in major U.S. LTO basins due to improved drilling plans. The U.S. Energy Information Administration (EIA) has already ramped up its assessment of technically recoverable U.S. crude oil resource each year this decade on the back of rapidly rising LTO resource, a trend that is likely to continue for the foreseeable future.
OPEC kingpin Saudi Arabia may have been built on oil, but the kingdom is now moving beyond it. In April 2016, then Deputy Crown Prince Mohammad bin Salman (MBS) announced Vision 2030, a blueprint to restructure and diversify the economy while expanding social freedoms for his subjects. The goal is to ultimately run a more balanced economy and budget, given the spreading belief that high crude oil prices are a thing of the past — barring a major supply disruption in the Persian Gulf region, which Saudi Arabia likely would not benefit. The planned Saudi Aramco IPO, a key element of Vision 2030, is an attempt to monetize oil in the ground while crude prices are still relatively high, and to use proceeds from the sale — and further sales based on comments by MBS — to help finance the kingdom’s economic transition.
In the shorter term, the U.S. shale oil revolution appears to have placed a US$70 per barrel cap on the price of crude, compared to US$100 or more for much of the decade to 2014. In the longer term, the potential spread of the LTO revolution to other countries, such as Argentina and Canada, as well as actions and technologies to combat global climate change, including the possible rapid adoption of electric vehicles, are likely to increasingly weigh on crude oil prices. Ali al-Naimi referred to climate action as an “existential challenge” to Saudi Arabia while still serving as energy minister, and in June 2016 his successor Khalid al-Falih said “we as human beings cannot be complacent and assume that oil will continue to fuel the world forever.”
In late 2016, in an attempt to get crude prices back on track, partly in support of the Aramco IPO planned for late this year, Saudi Arabia demanded and got major crude oil exporters outside of OPEC to chip in to rebalance the world oil market. And for the first time in history, non-OPEC kingpin Russia has actually complied to agreed production cuts. Russia is in the same precarious financial boat as Saudi Arabia, since the Russian government and economy are highly dependent on oil and gas revenue and most of the country’s gas exports are indexed to crude prices.
Saudi Arabia and Russia — formerly arch-foes, especially in the days of the godless USSR — have forged a strong diplomatic and economic relationship, including numerous bilateral investment agreements in the oil and gas sphere, since the original agreement between OPEC and 12 non-OPEC countries to cut crude production in December 2016. This new relationship between the two oil kingpins likely foreshadows ongoing co-operation between OPEC, Russia and some other significant non-OPEC oil exporters in an attempt to maximize crude prices and revenue as the world gradually transitions to a low-carbon world.