Who Holds The Power In Today's Oil Market?

Tyler Durden's picture

Authored by Osama Rizvi via OilPrice.com,

Amidst the din of analysts speculating about whether oil prices will rise or fall, observers may well be overlooking some pressing questions about the very nature of the global oil market. The most significant of these questions relates to whether Saudi Arabia is losing its grip on the global oil market and if U.S. oil and gas producers are replacing the Saudis as the key global swing producer.

By the mid-70s, the Kingdom of Saudi Arabia wielded the power to swing oil prices at its will by turning on and off the taps. Presently, after 44 years, the scenario is quite different. In fact, the recent Vienna accord where OPEC and NOPEC producers agreed to cut 1.8mbpd of oil, and now its possible extension, is symptomatic of the internal weakness. In 2014 when Saudi Arabia refused to cut production to stabilize prices, and instead increased production to protect market share, an oil price war began. But the strategy to drain out the high cost producers has gone awry. U.S. production continues to rise, while Saudi Arabia’s economy is suffering from lost oil revenue. U.S. Shale producers appear to be recovering market share and have managed to lower breakeven prices through a technological revolution.

Welcome to the era of “Fracking 2.0”, where a “company man” 100 miles away from an oil rig can give instructions to his workers via an app called “ISteer.” EOG Resources, one of the largest independent oil and gas companies in U.S. and ranked as Texas’ fifth largest gas producer, is doing wonders as it outperforms its competitors. EOG can now drill horizontal wells in just 20 days, which is down from 38 in 2014. The company has pumped consistent quantities of oil irrespective of the drop in prices.

And that is just one example.

At the same time, the production cost per barrel of oil for U.S. shale operators has decreased. Rystad Energy says that the break-even cost for U.S. shale is now $35 per barrel. Only recently such costs were three times higher than the Middle East and other non-Western producers and the depletion rate for such producers were much more punishing. But now the recovery rate, from 5 percent to 12 percent, may reach 25 percent in coming years. It is not a matter of if but when this technological revolution extends across all oil-producing regions outside the Middle East. There is strong evidence of the aforesaid rising oil production as well, with the EIA forecasting a U.S. daily crude output of 9.2 million barrels this year. It is expected to reach 9.7mpd in 2018. The rise in oil prices and U.S. production are directly proportional. This is one of the reasons that, as prices have recovered over past few months, we have witnessed a historic build in inventories.

 (Click to enlarge)

While the U.S. experiences this continued growth, Saudi Arabia has no option but to curb production and stabilize oil prices as more than 90 percent of their revenue depends on oil exports. In 2015 the Saudi’s were burning through their foreign exchange reserves at a perilous rate, which can create inflationary pressures. Saudi government subsidies and public entitlements were reduced while salaries and holidays were cut. The Deputy Crown Prince, Muhammad Bin Salman, faces an important and difficult task: stabilize the economy or face popular unrest. Therefore, the Kingdom, in an effort to wean itself off oil, launched “Saudi Vision 2030” and the “National Transformation Plan 2020.” The planned IPO of Saudi Aramco, the Kingdom’s national oil company, is a part of the Kingdom’s recovery strategy. By selling a five percent stake of this company, which according to some estimates is worth one trillion U.S. dollars (enough to buy Google, Apple, Berkshire Hathaway and Microsoft combined), the Kingdom is set to create the world’s largest sovereign fund. Such a step would diversify its economy and possibly eliminate the Kingdom’s greatest threat: social unrest. And now that there is a production cut with a more than 90 percent compliance rate, the Kingdom may be feeling more secure. In fact, according to reports, the Saudi’s economy has started to recover. Related: Goldman’s $50 Forecast May Prove Bullish

The OPEC deal, which was set to expire after the first six months of 2017, is likely to be extended for another six months which, given the importance of oil prices for Saudi Arabia’s economy, may mean the difference between survival or destruction.

Another positive move from Saudi Arabia is the reduction in tax rate for Saudi Aramco from 85 to 50 percent. This will help in ramping up Aramco’s value, which is the main revenue earner of the country. Saudi Arabia appears to have come to terms with the fact that it can no longer control the oil markets, and instead is focused on attempting to protect its economy.

Rising rig count, ballooning inventories, advances in shale technology and the already present supply glut. These are few of the signs that, notwithstanding the efforts by the OPEC producers to stabilize markets, the fundamentals remain unchanged and U.S. producers are regaining their strength. If the trend continues, will we see the U.S. emerging as a new swing producer?

In the world of oil there may well be two swing producers now. One is young and growing while the other is struggling to keep up with the times.

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flaminratzazz's picture

well it is official, Zero Hedge is trying to send their readers into shock.

Shemp 4 Victory's picture

This author is retarded.

How the hell is the US going to be a "swing producer" when it can't even supply its own needs?

cheka's picture

damn frackers busted the nyc.opec oil production suppression scheme

doubts?  look up the definition and purpose of a cartel.  to create ARTIFICIAL scarcity

what happened to oildrum.com peak pumpers? 

only thing more absurd is nyc's insisting on calling it FOSSIL fuel.  how many trillions of dinos are down there?  the bp well should've killed all fossil talk....but skype persist.  their arrogance leads to overreach, their achilles.  tick tock mfs

flaminratzazz's picture

we get the new electric tech while the third world gets our old stocks of full leaded.

johngaltfla's picture

LOL, who controls the future of oil?

Janet Yellen, of course.

If the Fed dilutes and cheapens the USD, why not buy oil at $10 per bbl cheaper than GCC rates with 90% lower insurance risk?

post turtle saver's picture

not all oil imported into the US is used in the US...

ThanksIwillHaveAnother's picture

SSL on website!  Won't donate until then!

bruno_the's picture

Well it costs $70 a year (or less). And about 30 min. of work (or less).

Writing bull about the fundamentals setting the oil price - priceless. 

RiverRoad's picture

Saudi Arabia was hell bent on driving our shale producers out of business.  Hasn't happened. 

sinbad2's picture

Saudi Arabia was following orders from Washington.

The idea was to destroy the Russian economy in the same way the US destroyed the Soviet economy.

It didn't work, because the Russians were prepared.

Davidduke2000's picture

Smart, this is the true story.

Fundies's picture

Jed Clampett ?

flaminratzazz's picture

the sauds have to keep that ole fvk from shooting at any more food.

sinbad2's picture

You can have Jed, I'll take Ellie May.

Oracle of Kypseli's picture

No matter how you slice it, who where what, the price is under pressure and there are a lot of produces with marginal profits who short oil above $49 just in case.

JB Say's picture

The old Saudi floor has been replaced by a Shale cap, $55/bbl and dropping very slowly. This will have a dramatic effect on ME politics.

sinbad2's picture

The old Saudi floor has been replaced by the Russian floor, but that will in time be replaced by the Iran floor.

Ecclesia Militans's picture

The current swing producer, Iraq, pays foreign upstream companies in crude as part of their licensing agreements.

Sudden Debt's picture

supply and demand?....


WHOEHAHAHAHAHAHAHAHAHAHA... I know... that's so 1999...

user2011's picture

I would say China.    China has enough reserve to sell oil back into the market.  Also, China can lower the oil price by saying their reserve tanks are full.   If they want to clear the glut, all they have to do is pump in and jack the price up.  

China is keeping Russian afloat.   And if China stop buying, there goes the oil cartel and the US shale oil.


VangelV's picture

China has no oil.


This is not true.  China produces around 4 million barrels per day.  But it sits next to Russia, which has plenty of oil to sell to China, which produces goods that generate the income to pay for the oil.  If the Chinese were to waste money on shale they could also play the same game as the US but that makes little sense and they are much more likely to use the low price environment to sign long-term contracts with producers or purchase oil companies that have seen their shares get crushed by the shale oil scam.  


VangelV's picture

Daqing is dying and China cannot offset its decline by investing in new fields.  It likes falling prices because a low price environment allows China to acquire equity positions in producers that need the cash at a time when the shale scam is driving prices lower.  I imagine that if there is a final correction that drives prices low enough the Chinese will step up and buy as many companies as they can until the shale sector coughs up the truth and confesses.  

sinbad2's picture

China already exports products made from oil, they value add and export. Australia gets most of its fuel from China, we used to have refineries, but Caltex(Texaco) makes more money playing middleman for the Chinese, so they closed local refineries.

China has a market edge, because they buy from Russia in Yuan, they get the oil cheaper than countries who use US dollars. They can even make a buck by just reselling crude, that's why their exports are booming.

sinbad2's picture

All the ME and most of the Russian oil costs less than 20 bucks a barrel to produce.

The US is engaged in a massive propaganda campaign to falsify production costs.

When costing US production, many of the costs are ignored, but when costing Saudi oil, the number of Ferraris the King intends to buy this year is added in.

At the current dollar value the US cannot compete with ME oil.

When the US chose to use ME oil, starting in the 50's, it was because it was cheaper and easier to extract, all the BS in the world will not change that simple fact.

Embrey's picture

That would be true if the ME could meet world supply. They cannot. If they could they would. They threatened by upping production into a market that was oversupplied. American shale producers used that crash in price (and the associated crash in the oilfield service industry) to demand lower costs from those service companies. So, the American shale explorers/producers drilled low-price horizontals and waited for the market to rebound before they completed them. That was when the American producer was at risk. If prices that were lower than our lifting costs domestically had prevailed for more than 5 years (enough for them to lose their leases/potential reserves for non-production) then the Saudi's would have made their point. The Saudi's flinched. Not because they were scared. Because they couldn't keep order for the 5 years necessary to bring shale producers to heel. The Saudi's lost. Game over. The end.

sinbad2's picture

US shale oil companies owe billions to the banks, that they cannot pay. The Fed(as reported by ZH) instructed the banks to cover up the bad debts.

Now it seems the major oil companies are buying out the shale oil players, probably for cents in the dollar, to get the banks off the hook.

So the majors will sell the oil, because it has cost them nothing. But it would be a safe bet that US taxpayers picked up the tab on the billions of bad debt.

Once the already constructed wells are played out, the industry will end.

Embrey's picture

Some do. Some do not. Plenty of companies have gone bankrupt. Many have not. You are speaking as if generalities should be specifically applied across the board.

VangelV's picture

I think that the shale story is one of the biggest scams in the history of finance.  For one, the companies are allowed to depreciate well costs by much less than the real world data suggests.  By using Estimated Ultimate Recovery rates (EURs) that are far higher than what the data suggests will be produced, the investors are expecting returns that will never be realized.  If we look at the Bakken, we see that the data is suggesting a total recovery of around 250,000 barrels per well for wells drilled in the better section of the formation.  Of this, 20% or more goes as a royalty payment so you are looking at a production of 200,000 barrels of oil paying off all of the other costs associated with production.  Note that about half of the money comes in the first three years after the well is drilled and that is where reality sinks in.  Given that most of the revenue shows up early in the game, how is it that the shale producers have managed to have such massive funding gaps that require issuing equity and taking on loans that can never be fully paid back?  This game is rigged and the people rigging it are working out of the Marriner S. Eccles building in Washington.  

Embrey's picture

By your example there are roughly 187,500 barrels of oil produced in a relatively short period of time. At $45/BBL that is almost &8.5MM. Subtract the cost of drilling that well, ad valorem and severance taxes and you still see a nice return in a relatively short period of time.
I do not deny that the financiers have their claws in some of the exploration/production companies. The reason they rose to such prominence in this equation was due to the amount of capital necessary to develop the properties the companies held in unrealized inventory.
The oil industry has adapted to the financiers and have sold off their 2nd tier assets so that they could have a war chest to develop their assets WITHOUT that level of investment by the financiers.
I am in the business. You are speaking theoretically. Oil/Gas production creates wealth (a function of mining, manufacturing and/or agriculture). Finance does not create anything. We are smarter than the financiers. We will win.

TheRealBilboBaggins's picture

I think people misunderstand the U.S. oil market. If we didn't import specialty oil for purposes of cracking into value-added products, we probably would look "self-sufficient" in oil.

But we never will. 

It is always cheaper to import crummy heavy oil from Canada or Venezuela as opposed to using light crude from North Dakota as we manufacture products down the tower from gasoline, etc.

So saying we shouldn't import any oil is like saying we should import any fine wood for guitar necks.  People who understand the business realize that such imports are a benefit to our country.

Nobody is ever  going to use heavy crudes (which are purchased at a discount) as a primary source of gasoline; but they will certainly use it to make asphalt.  If we do the upgrading, it means jobs on the Gulf Coast . . . good jobs.

So don't hope for "energy independence" if that has to mean we quit importing raw materials cheaply to make high priced product.

whatamaroon's picture

Buddy of mine last year had some messicans fill in his pool. In talking with them one of the messicans said he had worked at Hymlich-Payne (sp) drilling in the Permian basin but was laid off when prices sunk. I casually asked if they had any tokens working the oil fields, he said one but he acted white. Then the messican said the White guys were hard workers and surprised him. I just rolled my eyes and thought yea Motherfucker we built this country. The kicker was at the end of the day the messican whined about how long it was taking his illegal GF to get gov. bennies because she was pregnant and he was making a lot less money shoveling dirt.

ds's picture

There is a third vector ignored by those who are stuck in their universe that prices are determined only by demand/supply in the real economies. Traders and the financial economy exist. They price oil agnostically and neither OPEC nor the US shale oil industry can compel them. 

However, the writer is correct that the emergence of shale oil as a challenge to OPEC is correct. This also mean more spaces to play. It also mean that another space (shale oil) now exist to share the liquidity dances for energy plays. OPEC is evolving to be just one Saudi led club  where even other crude oil producining nations cannot afford to join as their own nations' budgets do not benefit from trade collusions. (Anothe win for traders).

US power over global energy increases if Trump decides to back the shale oil industry. This however is an internal US fight as there are vested interests that will block it for their favored ME paymaster (SA). The price of oil imposed upon global consumers is independent of physical demand/supply. It follows that the inflation/deflation that Oil engenders is artificial for each nation. Oil prices are the results of Politics and Power. Of course, great spin offs into political relevance of ME, non SA consortia, $ hegemony, etc. 

If you are not up to it to check Power, at least rise up from being the Muppets of Spins. Delusions do not help when you trade for gains.

p.s. Before you hail or rail against Trump, first unveil the Spinners' Agendas.


gcjohns1971's picture

A very few years ago all the intelligencia were debating "Peak Oil".

The Lesson:

The best guesses of the most educated and talented men are at best provisional approximations, to be swept away by the tides of chance.

To respect them too much is to surrender one's mind to fickle fate and tempests of fear.