By Andy Tully
When we think of the recent drop in oil prices, the question is not only who started it, but who’s responsible for keeping the prices falling.
Probably no one would dispute that the price plunge began with the eager and copious production of oil from shale formations in the United States. From the American perspective, that was beneficial because it was bringing energy self-sufficiency to a country with the reputation as the world’s largest importer of oil.
Despite unproven concerns about hydraulic fracturing, or fracking, a common way to extract oil and gas from underground shale rock, the practice has proven extremely productive. And that’s the source of the oil glut that began driving down prices in late June 2014.
Even one of fracking’s biggest supporters, legendary oil man T. Boone Pickens, blames the US shale boom for triggering the price slough that’s been hammering the energy industry. He’s doesn’t subscribe to the environmental concerns about fracking, but he says he can also recognize when his industry has latched on to too much of a good thing.
“I’ve fracked over a thousand wells,” Pickens, the chairman of BP Capital Management, said March 23 at a panel discussion in Monterey Calif. “I’ve never had a failure on one of them. … Texas, Oklahoma lead in fracking wells and it has been a great success for both those states.”
Yet Pickens thinks it’s time for US companies to take a break from their frantic production to allow oil prices to achieve some balance. In an interview with the Financial Times published March 18, he said shale companies have “overproduced,” and that it’s up to them to rein in output to help restore oil prices to a more profitable level.
So that’s where the price slump began, but is it entirely responsible for the average global value of oil to lose more than half its value in nine months, from more than $110 per barrel to a little over $50 today?
Consider Russia. It’s the world’s largest exporter of oil, which should be a benefit, but exporting cheap oil isn’t good for Moscow's budget, which relies on oil income for about half of its revenue. The simple answer is to produce less oil to help shore up prices. But that’s where weather gets in the way.
Reducing production could be harmful to Russia’s oil sector, in large part because the climate in most of the country’s oil fields is so cold that stopping production at some wells would freeze them up. And Russia can’t keep harvesting oil, then storing it to keep it off the market, because it has very little storage capacity. So Russian oil keeps flowing into the market, adding to the glut.
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So far we know that the oil glut and resulting price plunge began with US oilmen doing what oilmen do, and in part by Russia’s inability to taper its production of oil. But have we found a real culprit, a person or organization that isn’t merely contributing to the oversupply of oil but, in a sense, deliberately making things worse?
Consider Saudi Arabia, and, more specifically, its oil minister, Ali al-Naimi, considered the architect of OPEC’s decision to keep the cartel’s total production to 30 million barrels a day in a price war to regain market share for itself and its 11 fellow OPEC members. That decision, taken last November, may not have begun the glut, but is keeping it very much alive.
Al-Naimi said in an interview with the Middle East Economic Survey, published Dec. 22, that OPEC will maintain current production levels because its members produce oil and gas efficiently by simply setting up a drill and pumping out the fossil fuels.
Related: How Should Commodity Traders Now Think About Geopolitical Risk?
Evidently the Saudi minister believes that both the extra cost for fracking to extract shale oil or Russia’s inability to shut down production in Siberia are inefficient. Certainly they're more vulnerable to low prices than oil-rich countries in the Persian Gulf region. Soon shale producers won’t be able to make a profit on the oil they extract and Russia may be faced with a budget without revenues to feed it.
Al-Naimi’s strategy just may work, but perhaps only for the short term. Shale production and other “inefficient” methods of oil production may indeed diminish, trimming the glut and allowing prices to rally. But what happens if the price of oil rebounds as high as $80, $90 or $100 a barrel?
That's when the shale producers get back to work, and the whole cycle starts again. It’s quite possible that al-Naimi’s grand strategy may be nothing more than a brief diversion.
By Andy Tully of Oilprice.com