The massive growth of shale oil production decreased OPEC capacity in setting oil prices. In a context of limited demand growth, oil prices are currently in the $80~$85 price range and unlikely to exceed $80 next year.
The major factor in declining oil prices is to look on the supply side, says Michael Hsueh in the latest oil report published by Deutsche Bank. Libyan production increased from 0.24 million barrels/day in June to 0.78 mb/d in September. At the same time, Saudi Arabia production has plateaued around 9.7 to 9.8 mb/d. As for OPEC 30 mb/d quotas, if they were still generally followed at the beginning of the year, they were exceeded by 0.7 to 0.9 mb/d in September, said the German bank.
Since 1984, Saudi Arabia has taken a major share in supply reductions during the eleven oil cycles that occurred. Quota cuts decided in response to decreasing demand leading to a fall in crude oil prices take on average twelve months to be put in place and another three months for the price of oil to stabilize. Comparing the current situation with past cycles, Michael Hsueh calculated that the cartel would need to cut its production by 1.2 mb/d to balance the market, which is significantly higher than the past average production cuts.
This time, Saudi Arabia, with 2.7 mb/d of spare capacity, against 0.8 mb/d for all other cartel members, is determined to let the Brent price trade in a range between 80 and 90 dollars per barrel. Oil prices have actually been around $80~$85 since Oct.15. In order to maintain its market share in Asia, Saudi Arabia has started to offer discounts on its oil exports. For the country, there are 2 objectives: limiting the growth of shale oil supply in North America and put pressure on other OPEC countries to reduce their production. This strategy will also have consequences for countries that do not belong to the cartel, like Russia or Iran.
The German bank has calculated that the Saudi government has sufficient financial reserves to cope with an average price per barrel of $83 for 7.9 years. Russia, on the other hand, would only be able to cope with such a price for 3.8 years.
The next OPEC meeting will be held in Vienna on Nov.27. It should not change a situation that suits Saudi Arabia, when Iran now believes that the drop in prices is seasonal and balanced by a strong dollar. Also, cartel members are still far from being able to reach any kind of consensus. For example, Libya has requested an overall production decrease of 0.5 mb/d, while asking to be exempt from it.
US shale oil production should not decrease in the near future, despite declining prices. Producers have managed to reduce their costs and are unlikely to reduce their capital expenditures in 2015, focusing on the most profitable shale formations. The German bank has accordingly not reduced its production expectations for next year.
The forecasted increase in demand for crude oil were adjusted downward for 2014, from 0.8 to 0.7 mb/d and for 2015 from 1.2 mb/d to 1.1 mb/d. This is still quite a significant increase since it is close to the average of the 2000s. Consequently, Deutsche Bank cut its forecast of the average crude price to $88.75 in 2015 (-$8.25) and to $90 in 2016 and 2017 (-$10).
Declines in Goldman Sachs forecasts are even more drastic. The US bank expected a WTI price of $90 in 2015 but it now does not expect more than $75. Brent price should be around $85. To limit the growth of shale oil supply, crude prices will still have to significantly decrease, says Jeffrey Currie, head of commodities analysis of Goldman Sachs.
With shale oil producers adding each year the equivalent of Lybia‘s oil production, it was just a question of time before the market was in surplus, notes the analyst, especially since non-shale, non-OPEC supply is also increasing. Besides, despite geopolitical tensions, global OPEC production suffered few shutdowns. On the demand side, sluggish growth combined with continued energy savings across the board limits crude oil consumption increase. It will continue to rise but at a slower pace.
For Jeffrey Currie, this is a “new oil order” that is emerging in which the OPEC countries have lost their capability to influence oil price as it was the case only 10 years ago. Shale oil production now exceeds the available OPEC spare capacities, notes Goldman Sachs. Saudi Arabia no longer has the ability to push oil prices lower that North America marginal cost of production and reducing its supply would just offer most room for shale oil. The ability to set oil prices has moved from the dominant producer, Saudi Arabia, to the marginal producers who use new technologies to reduce their costs.