As expected, OPEC and its non-member partners (OPEC+) announced Friday that the group will reduce its production target by an additional 500,000 barrels a day, bringing total cuts down by 1.7 million barrels a day from the baseline level of around 45 million barrels as of October 2018.
OPEC+ reduced production by 1.2 million barrels a day beginning in January and extended that level in July through the end of this year. The additional reductions announced Friday will be reviewed in March at an extraordinary OPEC ministers’ meeting.
The announced additional cuts are unlikely to have any significant effect on overall OPEC+ production because the group has been producing crude at about that level for several months. Saudi Arabia, with a previous quota of 10.3 million barrels, has been producing less than it agreed to a year ago. Saudi Arabia’s average monthly production for the first 11 months of this year has been 9.8 million barrels a day. Other OPEC members that have fallen short of their agreed production levels include Angola, Azerbaijan and Mexico, though the declines were mostly due to political unrest or declining fields.
OPEC+ has not yet announced the production levels for individual members, but Russia, the largest producer in the group with a prior quota of 11.2 million barrels a day, will be allowed to discount the light oil (called condensates) that the country produces as a sideline to its natural gas production. Simple arithmetic will bring Russia into compliance with its new quota.
On Thursday, energy consulting firm Rystad Energy forecast that North American shale oil production will continue to rise even in the face of lower prices. The firm noted that “even with potentially lower prices, the production outlook for North American shale appears robust in the years ahead.” In other words, OPEC no longer drives world oil markets other than in the number of headlines the cartel generates.
North American shale oil (light, tight oil in industry lexicon) production this year will total about 8.6 million barrels a day, and that will rise at a compound annual growth rate of 10% to 11.6 million barrels a day by 2022. If West Texas Intermediate (WTI) prices fall to around $45 a barrel, North American production will level off at around 10.1 million barrels a day in 2021. If WTI prices rise to $75 a barrel, North American production will rise to a whopping 14.5 million barrels a day.
Other industry experts point to the decline of new wells in the primary U.S. shale fields, indicating that investors and lenders are not willing to continue throwing billions of dollars at a resource that has begun to show signs of stagnation if not decline. Initial production rates at horizontal wells are said to be falling, a result of producers front-loading the exploration and production dollars at sweet spots that have now been mostly exhausted.
Production is also said to fall off more quickly now than it did a few years ago, further bolstering the case for a lack of high-producing sweet spots.
The main reason to pay more attention to Rystad’s forecast, however, might be declining global demand for crude oil. If demand is actually eroding as the auto industry ramps up production of all-electric vehicles, then pumping more oil now at any price makes more sense than waiting for prices to rise. Waiting only raises the odds that hydrocarbon assets will decline in value.
Wouldn’t it make sense, then, for OPEC+ to open the faucets rather than close them? That might drive the price of crude so low that shale producers couldn’t survive. The cartel tried that in 2014 and got badly burned when shale producers quickly took advantage of the higher prices to borrow mountains of cash and drill more wells. That debt load is now suffocating many of the exploration and production companies as investors are demanding returns instead of more drilling.
That slow down would be good for prices if major integrated companies like Exxon Mobil, Chevron and Shell were not taking advantage of the struggling producers and acquiring more acreage in the major U.S. shale plays. The oil will always be in the ground, and these giants can afford to wait before pumping it out. That’s like holding a hammer over the heads of OPEC+.
The increased cuts to OPEC+ production, gauzy as they are, will be reviewed in March. Industry analyst Amitra Sen of Energy Aspects told Reuters, “Saudi Arabia … believes and so do we that OPEC will have to raise production in H2 2020 and hence the shorter tenure.” The announced cuts “put a firm floor” under oil prices for the first quarter of 2020, Sen added, and that helps prop up next week’s initial public offering of Saudi Aramco stock. The IPO priced at the top of its very narrow range and promises to raise $25.6 billion in fresh capital, making it the largest IPO in history by a narrow margin over the $25.5 billion raised when Alibaba went public in 2014.
After jumping to around $64.70 earlier Friday morning, Brent crude recently traded up about 1.4% at $64.29 a barrel. Forward prices also rose, but by smaller amounts. August futures rose $0.41 a barrel to $60.55. Traders are not looking for higher crude prices in 2020. By October, the Brent futures contract is trading today at less than $60 a barrel.