Market Trends: The U.S. Is the New OPEC

There’s a new OPEC in town. And instead of a collective of petroleum exporting countries, it’s a collection of Western-hemisphere states. United in their ability to use conventional and unconventional means to harvest oil, and, in some cases, defy production logic.

(And divided when it comes to Donald Trump.)

In November of 2014 a highly anticipated OPEC summit in Vienna concluded with a Saudi-led strategy to “defend market share,” a plan not so subtly designed to challenge a wave of non-OPEC production growth led by the United States and largely driven by unconventional oil. A little more than a year later, there are signs that the Saudi strategy is working — to a degree.

After peaking at 9.6 million barrels a day (mmbbl/d) in mid-2015, the most recent U.S. Energy Information Association (EIA) data indicates current production levels are just over 9.0 mmbbl/d and have ventured dangerously close to negative year-on-year growth in the final months of 2015.

Meanwhile, layoffs, mounting debt and plummeting rig counts have become standard fare for the nation’s once-booming shale industry. A similar story can be seen among a number of non-OPEC oil producers throughout the world, with 2016 expected to show production declines from Mexico, Norway, Russia and Oman, among others.

While these production declines are the logical outcome of OPEC’s strategy, 2015 offered a key lesson to global oil markets — betting against the resilience of America’s oil producers is often a losing wager. As such, American production (and not OPEC’s) is uniquely situated to be the world’s new swing producer in setting global oil prices in the year ahead.

One reason: As prices plummeted beginning in 2014, U.S. oil rig counts dropped accordingly. However, through the use of enhanced drilling techniques and increased efficiency, American production continually increased despite a 60 percent drop in operational rigs.

Of course, increased efficiency, however impressive, is not infinite. In recent months, the U.S. oil rig count has resumed its decline, this time dragging U.S. oil production along for the ride. As West Texas Intermediate (WTI) crude, the U.S. oil benchmark, touched a low of $37.75 per barrel in August, many in the industry had long estimated a breakeven price for the shale industry of more than $60 per barrel.

When American production finally began to decline, bullish speculators hailed the emergence of a long-overdue inevitability. Escalating liabilities, expiring hedges and an oil price set to trade in unprofitable territory looked like they would drag the U.S.-led shale boom back to normality.

Just as U.S. production defied fundamentals in rocketing higher, it is now set to defy the expectations of many calling for a prolonged production plunge. Certainly, the U.S. oil industry is currently under intense pressure. Producers forced to devote greater than 80 percent of their operating cash flow just to debt service obligations now account for millions of barrels a day in current production. But, as with most innovative conquests, in difficulty there is also opportunity.

While OPEC is able to act as the swing producer when prices move higher than the market wants to accept, the independent producers behind America’s oil boom are the ideal candidate to take this role when prices are uncommonly low. Iranian oil minister Bijan Zanganeh highlighted the issues facing the once-coordinated OPEC, calling for production cuts designed to lift oil to $70-80 per barrel, while reiterating that Iran had no intention of making production cuts of its own.

A somewhat similar sentiment can be seen in other OPEC members such as Algeria and Venezuela, as well as leading non-OPEC producers like Russia. OPEC’s oil-focused economies are struggling, with even the long stable Saudi economy burning through foreign reserves. Countries desperately attempting to balance budgets through oil sales are hardly interested in slashing that already limited income even further in order to lift prices sometime in the future.

Compare that to the U.S. where production cuts are much less political and much more a matter of simple economics. Production is declining because it is unprofitable at current prices. Once enough production moves offline, whether in the U.S. or elsewhere, prices will claw their way higher. Once those prices reach a sufficient level — the $60 per barrel breakeven point or perhaps even lower — some of that production will return, eventually sending prices lower once more.

Simply put, despite boasting less than one-third of OPEC’s output at its peak, U.S. production is poised as the swing producer, while OPEC’s market share strategy continues to divide its members.

In the U.S., vertical rigs are capable of moving from idle to operation in less than a month. With nearly 250 vertical rigs taken offline in 2015, the potential for a rapid production swing is substantial. Old wells can be combined with new techniques to cut costs and quickly respond to more favorable prices. In the same way that America’s shale boom pulled the floor out from the crude complex last year, it is likely to provide a ceiling in the year ahead.

While shale economics can’t wholly eliminate price spikes and geopolitical exposure, they have proven ably suited to redefine OPEC’s role in the global market at the same time that they redefine their own.

This is just one of six key trends affecting how companies buy and use energy in 2016. For a complete look, download the “6 for 2016: Global Energy Market Trends” whitepaper.

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