Why U.S. Shale Won’t Go To War With OPEC+

 | Nov 09, 2021 12:17AM ET

By David Messler

  • OPEC+ will be very happy with where oil prices currently are and is unlikely to change its course anytime soon
  • The U.S. does have the ability to increase production, but U.S. shale does not have support from either the government or shareholders to boost production significantly
  • The two bearish variables that could drag prices down in the near term are a strong dollar and the continuation of inventory builds

For years, the Kingdom of Saudi Arabia’s economy has suffered from low oil prices. Since 2014 when it increased supplies to try and break American shale producers, Saudi Arabia has had to struggle with a flooded market. Its cash reserves have been drawn down by hundreds of billions and it had to sell a small percentage of its prize asset, Saudi Aramco (SE:2222).

At the same time, Saudi Arabia’s Vision 2030 plan fell behind in its lofty goals of diversifying its economy. I discussed this at some length in a prior Oil price article. Now with the price of Brent - the benchmark against which Saudi Arabia prices its production - finally back above the $80 mark, the Kingdom is beginning to refill its coffers. So it was no great surprise when the Saudis and the Russians, the two principal members of the OPEC+ cartel, roundly rejected a demand from President Biden to increase production to ease the world’s energy crisis.

Up to this point, there had been some lingering concern on the part of OPEC+ that too high a price would reinvigorate the shale industry that had finally come to heel in early 2020. Restraint on the part of shale drillers since then has encouraged them that a new “war” for market share won’t be the result. As the Reuters article notes, while some American shale drillers are bumping up their budgets, many are standing pat. Kaes Van't Hof, the CFO of Diamondback Energy (NYSE:NASDAQ:FANG) was quoted as saying:

"The industry has tried a market share war with OPEC before and it didn't work out."

In this article, we will discuss what we see as being the major variables to the oil supply equation and where oil prices might go in the next few months. We think the world is in a new era of higher-priced commodities including oil, and several factors will sustain this condition for a number of years.

h2 The new energy Triumvirate/h2

There are three countries with the significant excess capacity to substantially increase oil supplies in a short period of time, KSA, Russia, and the USA. The IEA projects that KSA has about 12.25 mm BOPD of capacity or about 2.25 mm BOPD above present levels. S&P Global Platts estimates that Russia, currently producing 9.7 mm BOPD under the OPEC+ agreement, has an upper capacity of about 11.5 mm BOPD. Between the two they could quickly add 4-mm BOPD and knock prices down considerably if it was remotely in their best interests. KSA and Russia depend upon oil sales to fund their economies as they produce little else of value for the global market.

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The USA on the other hand is a giant of international commerce but still depends on its internal production to fund its approximate 21.3 mm BOPD habit. Russia and KSA have the clear objective of wanting to derive the maximum benefit from their production by optimizing the supply/price ratio. The U.S. has for years sent mixed messages to its domestic producers, a trend that’s only increased with the new administration. With its climate goals front and center the U.S. has tied the hands, figuratively speaking, of its domestic energy producers. Whether it’s the canceling of lease sales, denying permits on federal lands, opposing midstream takeaway, or implementing carbon taxes the American government has sent U.S. producers a very clear message.

h2 What should we expect from OPEC+?/h2

Consistency has not been a hallmark associated with the OPEC cartel in terms of sticking to output cuts, but since allowing the Russians to first participate in their meetings in 2016 has shown a much more deliberate approach to setting output goals. This new resilience came with some false starts, but finally, in 2018 the cartel (with the Russians) began withholding crude from the market and apportioning the cuts among its members. By 2021 they were able to declare victory.

Oil in the $80s means that each country can fund their internal and external demands as they look to maintain their economic growth and expand their geopolitical ambitions. We shouldn’t expect them to alter a course that took so long to craft and finally deploy successfully.

h2 What should we expect from American shale producers?/h2

Bank debt-laden and near bankruptcy, the pandemic of 2020 found many shale drillers already in the early stages of changing their corporate strategies. In the years that followed the oil crash of 2014 they had pursued a bank-fueled growth at any cost approach to development. This drove shale production ever higher year over year to the point, where even as the rig count had begun to decline from persistently low prices, it peaked in the first quarter of 2020 at 9.3 mm BOEPD.