First oil

“We were eyeball-to-eyeball and the other fellow just blinked.”—U.S. Secretary of State Dean Rusk during the 1962 Cuban missile crisis.

The Cuban missile crisis was a classic eyeball-to-eyeball confrontation. After the Soviet Union had placed nuclear missiles in Cuba, the U.S. imposed a naval blockade to prevent additional missiles from entering the island nation that is only 90 mi from Florida. After a tense, 13-day confrontation, the Soviet Union agreed to dismantle its missiles already in Cuba, in exchange for a U.S. public declaration not to invade Cuba without direct provocation. In secret, the U.S. also agreed to dismantle U.S.-built missiles deployed in Turkey and Italy against the Soviet Union.

At this time, there is an eyeball-to-eyeball confrontation between OPEC members and U.S. shale producers over crude oil market share. OPEC’s 12 member nations produce 30 MMbopd. Total U.S. crude oil production (conventional plus shale) has increased from 5 MMbopd in 2008 to 9 MMbopd in 2014, due primarily to liquids production from shale plays, such as the Bakken, Eagle Ford and the Permian. According to a Goldman Sachs study, as reported by Reuters, the world is producing 700,000 bopd in excess of total demand. Consequently, crude oil prices, both Brent and WTI, had dropped by about 20%. After the OPEC decision on Nov. 27, oil prices dropped an additional 10%, to below $70/bbl.

While U.S. crude oil production does not reach international markets, due to a ban on the export of oil (other than exceptions for Alaskan crude and marginal exports to Canada) since 1975, the additional barrels do impact the worldwide movement of crude oil and its prices. Light crude oil from U.S. shale plays is increasingly displacing imports of crudes from Nigeria and the Middle East, that have served as feedstocks to U.S. refineries. This crude is now available on the world markets, and it is impacting OPEC’s Asian market share.

The rich OPEC nations, such as Saudi Arabia, UAE and Qatar, could ride out the low-price market for a few years. However, the relatively poor OPEC countries (Venezuela, Iran, Iraq, Nigeria and Libya) were hoping for a 1-MMbopd production cut, to help sustain oil prices above $80/bbl. Iran is already suffering from U.S. and EU export sanctions. Outside OPEC, Russia is suffering from both low oil prices and sanctions. The Russian ruble has weakened 37% against the U.S. dollar this year, including a 13% drop in November. In fact, some conspiracy theorists have suggested that the Saudi Arabian insistence on protecting market share hinges on a U.S.-Saudi attempt to weaken Iran and Russia. They point to the collapse of the Soviet Union during the Reagan administration as a
historical example.

Who will blink first? I’m afraid it may have to be the U.S. shale producers, who have only an economic motive and don’t necessarily have to cater to other motivations to keep fields operating, such as keeping employees working or protecting the national interest. If the global oil and gas industry was controlled by one entity, it would make sense to use the same economic logic that oil companies use to make their project investment decisions. Ideally, this global operator would exhaust most of the oil in the Middle East, which has the lowest lifting cost, and then fund the large offshore projects, followed by North American shale, and finally, the heavy oil and oil sands projects.

I expect to see a low-price environment for the foreseeable future. The U.S. shale production may dwindle to the prime sweet spots in the Bakken, Eagle Ford and the Permian. The low-price environment has served as a quantitative easing of more than a $1 trillion for the world economy. Over time, global spending and manufacturing will increase and the oil prices will start moving up once again. How quickly the transition will take place is anybody’s guess.