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A Single Country Now Controls the Future of Oil

by | published March 16th, 2016

After a hefty rise of 46.9% for the month through close last Friday, WTI (the U.S. crude oil benchmark) has fallen for two consecutive sessions.

As always, pundits with no real experience in the industry will blame the “glut” – as if this really explains anything.

Remember, in the summer of 2014, we had a greater surplus of crude at Cushing, OK (where WTI is set) than we do now.

And WTI was trading above $100 a barrel.

Clearly, excess supply on its own is not responsible for today’s oil conundrum.

Instead, the key factor in how people regard the market and anticipate prices today is guaranteed excess supply.

And the actions of a single country will now decide whether that guarantee will remain…

U.S. Shale Oil Guarantees Excess Supply

Here’s what’s throwing the traditional supply and demand balance out of whack. The market now knows there are significant volumes of extractable unconventional (shale and tight) oil in America that could be brought to market in short order.

Whether that volume will be brought up is, of course, largely a function of demand and price. The former is rising globally but hardly at either the level or the rate of known reserves. Price, therefore, becomes the key factor.

At $60 a barrel, most U.S. unconventional oil can be produced at a marginal average profit. But that’s not the case at $40 a barrel, or even $50 a barrel.

Keeping oil prices low enough that this American oil stays in the ground remains one of the bulwarks of OPEC’s policy of defending market share.

But this has come at a hefty cost. All OPEC producers are running significant and expanding budget deficits. Those budget deficits are intensified by declining export revenues and made even worse by the need to import just about everything else.

After all, these are not diversified economies: everything you might want (other than petrochemicals) must be imported for hard currency.

This situation is made worse by the way Middle Eastern OPEC members avoided the worst aftermaths of the so-called “Arab Spring.” In short, they bought their way out by expanding social programs and domestic spending.

Today, no OPEC nation has that luxury anymore, just as what I have termed “Arab Spring II” approaches. Even Saudi Arabia is cutting spending and increasing taxes.

Some OPEC economies – Venezuela, Libya, and Nigeria being the worst – are either careening headlong into crisis or are already basket cases.

The key thing to recognize – and which was strongly emphasized by discussions at the recent Windsor Castle energy meeting – is that OPEC members have been increasing exports, selling additional oil into an already saturated market, for two reasons.

First, despite depressing the price, additional sales remain the only way that these countries can acquire essential revenue.

Second, OPEC has acknowledged that there is no longer any reason to keep their oil in the ground.

This second point is dramatic. If oil were at a higher price (say, north of $60 a barrel), the strategy of keeping reserves in the ground would make more sense. Think of it as a commodity savings account.

But right now, the only thing accomplished by not pumping oil is allowing others to take up market share. So, OPEC nations end up in the unenviable cycle of shooting themselves in the foot to retain share of a market in which profits are declining – because of their own actions.

This brings us to the cancelled late-March meeting between OPEC and Russia…

A Production “Freeze” Would Stabilize Oil Prices

Recently, rumors suggested that OPEC and Russia would reach an accord on capping oil production in a meeting in Moscow before the end of March. Now, no production cuts were ever anticipated – just a cap on production.

After all, as those of us who remember how these things have played out in the past know, the Kremlin has never agreed to an oil production cut and then kept its promise.

Now, OPEC may regard the U.S. shale patch as its main adversary in the fight over market share, but there is just no central way to control U.S. production, either through the government or through national oil companies.

But there is in Russia.

What OPEC needs is an agreement that includes commitments from the main non-OPEC oil sources. Moscow certainly fits that bill.

The production cap also has a ready-made focal point: by using January’s production figures, the production limit put a cap on production at close-to-record-high levels.

In other words, nobody would really be giving away anything by agreeing to the deal – least of all leverage.

Even so, the deal would stabilize and increase prices, because oil traders would finally be able to see a ceiling to the volume brought to market. In other words, the deal to “freeze” oil production would effectively remove the guaranteed excess supply that has been pushing down prices for so long.

However, Iran has not agreed to the deal, for reasons of its own…

Iran Needs Western Technology – Fast

Tehran is only just coming off Western sanctions that have paralyzed its economy, denied essential investment in its oil and natural gas production, fields, and infrastructure, as well as decimated the country’s banking sector.

Iran urgently needs more revenue from oil exports. As you can imagine, putting a cap on how much Iran can participate in a game it has long been denied the chance to play is not popular in the country.

No wonder Tehran is resisting a production “freeze.”

On the other hand, going alone isn’t acceptable either, as Iran has been experiencing huge problems in its main oil fields. Without access to Western technology, expertise, and funding, the country’s oil sector will remain in shambles.

At many major oil fields, pressure is so low that the gas that usually comes up along with oil has been lost. Pipelines are rupturing on a regular basis, and petrochemicals produced in the country have an irritating habit of simply exploding.

In short, Iran needs access to outside help fast. For all the talk of the country increasing its exports by 500,000 barrels a day, that rate will take time to reach, and is not sustainable given the current state of affairs.

Here’s what’s likely to happen.

OPEC (read: Saudi Arabia, which calls the shots) will give Iran a modified pass here, granting it some exceptions to the general production deal, and Tehran will show up at the negotiating table sometime in April, just like everyone else.

That should help oil prices stabilize, and is yet another reason to conclude that the bottom in oil was hit earlier this year, when WTI closed at $26.55 a barrel.

P.S. Marina and I are once again catching a flight to London, where I’ll be attending an energy session in the House of Lords – the upper chamber of Parliament. I expect some exciting developments from there.

Stay tuned.

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  1. david lundgren
    March 16th, 2016 at 15:45 | #1

    Doesn’t the American economy benefit more from lower oil prices? More money to spend in other sectors thus picking up the economy? You would think gasoline prices should stay low for the benefit of the most people.

  2. Val. Vallejo
    March 16th, 2016 at 21:12 | #2

    Good luck. I’m an oil rig mechanic in Ca.& got Laid off, help me & the rest of the US oil field get back to work ASAP. Keep us in mind when negotiating please. Thanks, Val.

  3. Val. Vallejo
    March 16th, 2016 at 21:14 | #3

    This was good news

  4. The Road Warrior
    March 16th, 2016 at 23:53 | #4

    It seems to me that, over time, oil prices should stabilize (without any agreements to production cuts or caps) at around $60- per barrel. South of $60- per barrel, shale production would not be economical (accepting Dr. Moors’ figures), so the price of oil should rise over time as it did before shale production, until it becomes economical to begin shale production again. Then the lowest cost shale producers should start up again, but as more and more shale oil is produced, the market will begin to become saturated again, and the price should start to fall. Supply and demand at work. Oil should trade in a range where some shale production is feasible, but not too much.

  5. March 17th, 2016 at 05:50 | #5

    Thanks for your astute views! Looking forward to your next report!

  6. Chris pra
    March 17th, 2016 at 14:10 | #6

    Thanks for the insight. I, also will be waiting for some good news from the London meeting. I am also one who has given 20 yrs to the oil patch and now I’m laid off like so many .

  7. Terry
    March 17th, 2016 at 17:48 | #7

    Everybody needs to wake up – I have been manufacturing oil field equipment for a long time. I own a CNC machine shop and with the way oil prices are, lots of my friends are out of work and I will be closing my shop as well- economy seriously bring up price of oil!

  8. March 17th, 2016 at 21:48 | #8

    What western technology does IRAN need when it buys military weapons from Russia ? Although that was a mistake from Russia they now know as Iran controls far more than Russia knew before, which is the way of the past for that area.
    The answer is simple, for Iran to have patience and put oil in a another country’s protected storage or boats, for the future payment of what is needed today in terms of things like food, a loan paid with special conditions or value not interest, or other things away from their control with them paying for the time of the storage and receiving needed products for their people, to keep pressure on them to comply, and to show support for compliance. Of course this would be stepped help not all at once. Any next EASY problem to solve? I know everything is complex and it all depends, I just thought how little anyone else does to solve problems with something that helps everyone because of their greed and conflicts and personal agendas.

  9. wim
    March 18th, 2016 at 12:47 | #9

    I feel very sorry for your job. Hope you find a way to overcome your financial needs

  10. J Brown
    March 22nd, 2016 at 12:16 | #10

    How in the world did Saudi Arabia get into a position of possibly owning the largest oil refinery in America, Port Arthur in Texas? That’s akin to a foreign country owning the White House. Just sayin, that is the height of stupidity.

  11. Sybil
    March 23rd, 2016 at 11:57 | #11

    Everything has a price tag, unfortunately that includes your country.

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