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After Messy Price War, OPEC Gets the Blues, Can’t Figure Out How “to Live Together” with US Shale Oil

, February 23, 2016, 0 Comments

oil-opec-dollar-Marketexpress-inOPEC Secretary General Abdalla Salem El-Badri admitted on Monday that the price war has backfired.

While it still controls about 40% of global oil production, OPEC has been losing market share to US and Canadian producers. So to escape the dreary fate of becoming an irrelevant cartel, it unleashed a price war at its Thanksgiving 2014 meeting by refusing to cut production. And oil fell off the chart.

The casualties are piling up everywhere. Countries like Venezuela and Nigeria are teetering. Russia and Brazil have plunged into deep recessions. Petro-currencies have swooned. State-controlled oil companies like Pemex or Petrobras are hoping for a bailout. The sovereign wealth funds of Norway, Saudi Arabia, and other oil-producing nations have had to dump stocks and bonds to fill budget holes. Dozens of smaller US shale-oil and offshore drillers either have already defaulted or filed for bankruptcy. Investors have lost their shirts. Even the “smart money” got cleaned out.

The price of WTI hit $26.19 a barrel on February 11, the lowest since May 2003. And OPEC was not amused. So Secretary General Abdalla Salem El-Badri blamed US shale oil drillers for mucking up OPEC’s elegant price-war strategy.

“Shale oil in the United States, I don’t know how we are going to live together,” he told energy executives at the annual IHS CERAWeek in Houston on Monday, according to Bloomberg:

OPEC has never had to deal with an oil supply source that can respond as rapidly to price changes as U.S. shale, El-Badri said. That complicates the cartel’s ability to prop up prices by reducing output.

“Any increase in price, shale will come immediately and cover any reduction,” he said.

In a rare admission that the policy hasn’t worked out as planned, El-Badri said that OPEC didn’t expect oil prices to drop this much when it decided to keep pumping near flat-out.

So last week, cracks emerged in OPEC’s elegant price-war strategy when a group of countries, including Saudi Arabia and Russia, agreed in principle to freeze oil production, hilariously, at current balls-to-the-wall levels, provided that other oil-rich countries, particularly Iran, which is just now starting toramp up production, join in as well. But, as we pointed out, “political baloney doesn’t fix the fundamental issue” [read The Saudi/Russia Oil Deal “Just a Bunch of Bull”].

“This is the first step to see what we can achieve,” is what El-Badri said about this oil deal. “If this is successful, we will take other steps in the future.”

He refused to specify what these “other steps” might be, and alternatively what OPEC might do if this deal is not “successful.”

But there’s hope for OPEC, according to El-Badri: the price collapse has caused companies to cut capital expenditures too much, which down the road could create a squeeze in supply and “a very high price.”

“The concern is no investment now, no supply in the future. It’s as simple as that,” he said. “If there’s no supply coming to the market, prices will go up.”

That’s what he wants in his sweet dreams. And it contradicts his nightmare about US shale being able to respond “rapidly to price changes.”

But before this “very high price” can set in, there will be a lot more bloodletting, according to the IEA’s report, also released on Monday. Like prior reports, it kicks the end of this oil bust further into the future.

The IEA now figures that US production might decline by 600,000 a barrel a day over the course of 2016, and another by 200,000 barrels day in 2017, when the market “will begin rebalancing.” But then it will start all over again as “a gradual recovery in oil prices, combined with further improvements in operational efficiencies and cost cutting, allows production to resume its upward climb” in 2018. By 2021, the US and Iran will likely be “leading production gains among non-OPEC and OPEC countries, respectively.”

Forecasts in early 2014 have proven to be painfully wrong. The future doesn’t listen to forecasts. But the report did have an element that rang true:

“Anybody who believes that we have seen the last of rising” shale oil production in the US, “should think again.”

How fast US shale oil production can respond to price increases is the big question. By then, whether it’s 2017 or 2018 or later, more oil companies, including some larger ones, will have gone bankrupt. The survivors are left with wrecked balance sheets. Rigs and other equipment will have degraded and won’t be instantly ready or available. Laid-off workers will have dispersed. And after this much capital destruction, beaten-up bankers are going to be leery, investors are going to be shy, and capital is going to be expensive.

So investment in new production is going to be slow. That could create the supply squeeze El-Badri is dreaming about. OPEC would only be too happy to supply the crude at “a very high price.”

But never underestimate just how fast global money can respond when it sees in its wildest dreams that oil might once again hit $150 a barrel. And that money would kick off the glut all over again. That’s El-Badri’s nightmare.

But for now, the upside for oil is extremely limited. Read…  Another Doomed Rally in Oil