Low oil prices will linger longer

Experts: OPEC’s strategy fails to cut U.S. production

This chart shows that OPEC has kept oil production steady even as prices have plummeted. Analysts say the cartel's goal is to keep its market share in the United States despite America's booming shale production.
This chart shows that OPEC has kept oil production steady even as prices have plummeted. Analysts say the cartel's goal is to keep its market share in the United States despite America's booming shale production.

When crude prices first plummeted last year in the face of a global oil glut, OPEC had one response: Keep pumping oil.

And the cartel, led by Saudi Arabia in the decision, has done just that -- refusing to cut production even as the downswing in the global market deepens, and threatens to throw some of OPEC's members' economies and governments into turmoil.

The move by the Organization of the Petroleum Exporting Countries is linked to lead producer Saudi Arabia's desire to safeguard its share of the market against the rise of U.S. shale production, analysts say.

But so far the cartel's strategy has been unable to significantly reduce U.S. production, meaning that OPEC and domestic producers, such as El Dorado's Murphy Oil Corp., are in for a longer period of low oil prices, analysts say.

"This maintaining high levels of production has been pretty effective in reducing the oil prices, but it really hasn't had much affect yet on U.S. oil production," said Jim Krane, an energy research fellow at Rice University's Baker Institute for Public Policy.

But, he said, "I don't think the Saudis are going to back down first in a price war."

The slump in the oil market began almost a year ago as the global market became oversupplied and demand began to slow. The bulk of the increase in supply came from the surge in production from U.S. shale plays.

The market got a small, short lift in the spring, but prices began to fall again on signs that the global glut has yet to abate and that demand for crude (especially with the weakening of the Chinese economy) was slowing further. This has led to a 30 percent drop in the price of oil since it peaked in June.

A year ago, oil was selling for more than $100 a barrel. Oil in New York was priced under $40 a barrel last week for the first time since the 2008 financial crisis.

In November, soon after oil prices started to plunge, OPEC decided to forgo a production cut. That marked the start of a price war.

Historically, OPEC forced prices higher by reducing production levels, or lowered them by flooding the market.

"However, what has happened over the last two to three years, Saudi Arabia is no longer in that position because of what has happened with shale oil and shale gas," said Hossein Askari, Iran Professor of Business and International Affairs for the Elliott School of International Affairs at George Washington University.

"More importantly, Saudi Arabia cannot control prices as well," he said. "It does not have as much power because there's so much excess capacity outside of Saudi Arabia."

If Saudi Arabia, and as a result OPEC, decided for some reason to reduce its production levels, the market would see an upturn in prices, analysts said.

"I do believe that the markets are looking for somebody to blink in this situation," said Bill Ebanks, managing director at AlixPartners LLP and co-head of the firm's Oil & Gas Practice.

But the chances of the cartel and Saudi Arabia making such a move is unlikely. Since the meeting in November, both have remained reluctant to take action.

Saudi Arabia wants to remain dominant in the oil market and persuade outside producers from bringing too much oil on stream, analysts said.

"For the last five to six years, the larger producers of OPEC have watched on the sidelines as the U.S. has rapidly grown production," Ebanks said. "They want to be in control of the market. They want to be the producers that essentially set prices."

In response to lower oil prices, energy companies have made large cuts in spending. Murphy Oil reduced its spending for the year by about 30 percent and its workforce by 7 percent during the second quarter of 2015.

Analysts said more layoffs and spending cuts could soon be on the way because domestic production remains strong.

"It certainly hasn't progressed in a way [the Saudis] want it to progress," Krane said. "Some big oil companies have cut back budgets for future capital spending ... but it really hasn't done much to cut the flow of oil from existing wells now."

While the plunge in the oil market has hurt the "growth phase" of oil U.S. shale production, it has not reduced output enough to significantly balance the market.

"I feel the sentiment within the industry has changed," Ebanks said. "U.S. domestic producers have clearly come to realize that this is not going to be a short period and they are certainly expecting low prices to continue for the foreseeable future."

Saudi Arabia's motivation for maintaining and even increasing output is not just to keep its share of the market. It's also political.

"U.S. oil sector is basically governed by economic rule," Krane said. "In Saudi Arabia they aren't thinking along the same lines."

There, he said, "it's really long-term political stability, and ultimately regime survival."

Iran, which was OPEC's second largest producer before sanctions in 2012, has also come out in recent weeks to say that it will fight for market share. After reaching a nuclear deal with six nations led by the United States, Iran has said that it will move quickly to export its oil if sanctions are lifted.

Iran is also hoping that once sanctions are lifted, it will revive investment in its oilfields by Western energy companies, analysts said.

Iran and Saudi Arabia are rivals in the oil market and in the region, including most recently in the conflict in Yemen.

"Saudi Arabia's political goal is to make sure that Iran's revenue -- oil revenue -- doesn't go up," Askari said. "If this deal had not been reached, I do not think Saudi Arabia would be doing this."

Askari said he expects oil prices to stay between $35 and $60 a barrel for the next seven to 10 years, barring any type of event that would push prices higher.

And he said that while Saudi Arabia is running at a budget deficit, the kingdom can afford to keep prices low for at least seven years and can make it even 12 years if some expenses are cut.

"They've got a big nest egg built up to help them survive what's looking like an oil bust," added Krane with the Baker Institute.

The same cannot be said for all OPEC members. Countries that have been hit hard by the price drop, such as Venezuela and nonmember Russia, are pushing for an emergency meeting to develop a strategy to stop the oil rout, The Wall Street Journal reported last week.

OPEC does not meet again until December and is unlikely to meet before then. Previous calls for emergency meetings have not been successful.

"It is hurting obviously countries that need the revenue quite desperately," Askari said, adding that with the fragile state of some of the countries, the oil rout could result in uprisings against their governments.

"I think it can result in turmoil," he said. "In all the OPEC countries, but in some non-OPEC countries oil is used to buy the people. Oil revenues are used by those in power to stay in power."

SundayMonday Business on 08/30/2015

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