Comments: Just Another Cycle?
Authors: Donnelly John 
Published: February 2015

Editor's column

One question raised about the sharp slide in global crude oil prices is whether this is just another cycle in a volatile business that has certainly seen its share of ups and downs, or a more significant shift in the relationship between producers, namely OPEC, and consuming countries. The current situation has been painted as a battle over market share between Saudi Arabia and North American operators that have achieved enormous success ramping up the output of unconventional supplies in places such as North Dakota, Pennsylvania, and south Texas.

Similarities between the current state of the oil market and the mid-1980s cannot be avoided. Then, Saudi Arabia’s oil policy change that was intended to keep or gain market share sent prices plummeting. It took approximately 2 decades for prices to recover, which led to more streamlined operations by operators and a rash of major mergers and acquisitions. It also led, in part, to a significant shift in how industry research and development and technology innovation occurred, as major operators ceded that function to the large service companies, which became the chief drivers of innovation.

Since the 1990s, Saudi Arabia has been the industry’s “swing supplier,” adding or subtracting supplies to the market to keep supply/demand and prices in balance. For OPEC members, heavily dependent on current and future oil revenue, a stable oil price and surety of demand are paramount. Saudi Arabia Oil Minister Ali al-Naimi has said that he believes that higher-cost non-OPEC production, including US tight oil, will be driven out of the market if low oil prices persist. The effect of this is already occurring as oil prices have fallen by roughly half to around USD 50/bbl, and could go lower. Wells have been shut in, rig counts are down sharply, and operators and service companies have announced layoffs.

What is untested is the ability of unconventional supplies to be quickly turned on and off, a difference from the mid-1980s, and what the clear break-even price is, if there is one. Tight oil has shorter lead times and cheaper initial costs than most conventional development, which means it could become the new swing supplier in the global market, wresting that ability from OPEC members. Unconventional production, in projects such as the prolific Eagle Ford Shale, is also becoming more efficient and the price decline promises to further increase efficiency. Analyst Wood Mackenzie predicts that in the current environment, costs in the Eagle Ford will fall by 20% for drilling and 10% for completions, making sub-USD 50/bbl viable. Also untested is the resolve of OPEC members to stay together. While countries such as Saudi Arabia, Kuwait, and the UAE have publicly pledged a commitment to the current policy of driving down global prices, less wealthy OPEC members have tough days ahead with their oil revenues down by half.

For major producers such as Saudi Arabia, there are other things to worry about. Higher oil prices drive interest in competitors to hydrocarbons such as alternative fuels. As concerns about climate change become more widespread and a global UN climate change conference, whose objective is to achieve a legally binding and universal agreement on climate from all nations, looms this year, some hydrocarbon producers fear additional regulations. Al-Naimi, a frequent attendee of global climate talks, expressed fear about what may be on the horizon. “All of these are good for humanity,” he said about efforts to improve climate change policy, “but they will be definitely a threat to oil demand in the future.” JPT