Impetus Behind OPEC's Oil Oversupply Strategy

Current oil price war misunderstood by many. 

Maintaining market share isn't the root of the battle. 

Why OPEC may never be able to turn off the spigots. 

Over the long term, OPEC's loss of market share is foregone conclusion. 

If there wasn't so much at stake for oil investors, it would be amusing to comment on the analysis foibles of those continuing to suggest the reason OPEC is being pressured to continue production and supply levels so high, is in order to maintain market share.

What most are missing is market share is still a metric being used to represent the outcome of supply increases, but it's no longer the impetus behind maintaining supply at current levels, and even increasing it over the next year or two.

The problem most aren't seeing is this: what will OPEC do once it reaches the alleged market share position it is seeking to maintain, in light of the known recoverable shale oil reserves around the world?

more on what's driving OPEC's oil supply strategy

How Bad Can It Get For Shale Oil?

Summary

There is nothing Saudi Arabia or OPEC can do about shale oil over the long term.

At best they can only delay the inevitable.

Millions of barrels of shale oil will be introduced into the market over the next decade.

Companies with shale exposure, over time, will take market share away from OPEC.


From some of the headlines I've read recently, you would think the U.S. shale industry has been defeated by Saudi Arabia and OPEC, and everything in the oil sector going to return to where things were before shale producers entered the market.

Not only is this a fallacy, it is the exact opposite, which is why the strategy of oversupplying the market will remain in place for now in order to keep the price of oil low, which in turn makes it more difficult to invest in new exploration and development.

The idea of market share being the battleground being fought over is a misguided one because, that would suggest shale oil can be defeated around the world. It's not going to happen. It won't even happen in the U.S., let alone the world.

In the short term there will continue to be pain in the shale segment of the oil sector, as more companies will be forced to go bankrupt, and those that are stronger will have to put development on hold until more favorable market conditions emerge, which of course means a higher oil price.

more on worst-case scenario for shale oil

It's OPEC against OPEC!

Summary

OPEC's greatest competitor is now OPEC.

The real reason OPEC oil production levels will remain high.

What the market is transitioning into.

Is a real free market oil industry emerging?


There are a lot of variables behind the reason the price of oil has plunged, as producers ramp up production in an attempt to maintain market share.

When Saudi Arabia and OPEC decided to boost production in response to the serious threat of U.S. shale oil, that was the primary impetus behind pushing prices down, in order to put extreme pressure on the quickly-growing shale competitors before they were too big to be dealt with.

As time as passed though, and U.S. producers have been forced to lower production levels and reduce exploration and development spending, a scenario has emerged that has gravitated to OPEC itself.

With Iran about to be released from sanctions, it has aggressively and publicly stated it will take steps to gain back market share it has lost, and will do what's best for the country, which was a reference to ignoring anything Saudi Arabia had to say about it.

This is one of the reasons the latest OPEC meeting was meaningless, as it was already known by those that really follow the industry and understand what's going on, that there was no chance of an agreement being reached on production cuts. It's doubtful it was even a serious part of the conversation, if it was brought up at all.

more on OPEC's internal competition

Oil | Forty Dollars the Low for oil?

Now that oil futures prices have traded above the $40 mark for a couple weeks, some are concluding that the bottom may have finally been reached for the black gold.
After hitting a four-year low of $32.40 a barrel on Dec. 19, oil has now rebounded more than 20%. While occasionally falling below $40 in intraday trading, it has closed above $40 everyday since Jan. 20. Similarly, national average gasoline prices have risen above $1.90 a gallon from below $1.70 a month ago.
"While crude-oil markets may remain vulnerable to further disappointments in [...] economic conditions, there is also the potential for a price base to be forming," wrote Brenda Sullivan, an analyst at Sucden Financial Research, in a note.
Ultimately, analysts say the future direction of oil prices will depend on the outcome of the struggle of two opposing forces.
On the one hand, the weakening global economy is expected to lead demand for oil to fall for a second year, marking the first two-straight-year decline in decades. On the other hand, the Organization of Petroleum Exporting Countries is expected to continue cutting production at a record pace to put a floor under prices.
High stakes
The stakes are high for investors who are bullish on oil, especially those who've poured record amounts into oil exchange-traded funds.
Data showed investment in oil ETFs, a convenient investment channel for retail investors, has reached record levels. The number of crude futures contracts held by the United States Oil Fund (USO) , the largest oil ETF, hit a record high near 80,000 recently. One contract represents 1,000 barrels of oil.
Last year, the commodity proved one of the best ways to earn a lot of money - and then, to lose it all. After hitting a record high of $147 a barrel in July, oil fell more than $100, or 70% by year-end. It closed 2008 down 54%, its biggest loss ever and more than the stock market's tumble.
Trading in the first months of this year also didn't bode well for oil bulls. Crude has lost 10% so far this year, compared with a 5% loss in the Reuters/Jefferies CRB commodities index, and a 4% gain in gold prices.
On Friday, oil fell 2% to near $40 a barrel on the New York Mercantile Exchange after the U.S. reported a 16-year high unemployment rate. See Futures Movers.
Some analysts predict oil prices could fall to as low as $25 in the second quarter. The inflation-adjusted record low for Nymex oil is at $18.90 a barrel, hit on April 1, 1986. In non-adjusted dollar terms, that low was $9.75, the only time in Nymex history that oil fell below $10.
OPEC cuts production
Investors aren't the only ones wanted oil prices to stabilize. The 12 OPEC member countries, whose revenues heavily depend on oil prices, have made record cuts in their production.
Some of the members of OPEC said they want to see oil prices rise to at least $60 a barrel.
At its December meeting, OPEC agreed to reduce production by a record amount of 2.2 million barrels a day, starting from Jan. 1, adding to previous cuts of 2 million barrels. Overall, the reduction is equal to about 5% of the world's oil demand, which should easily offset any drop in demand, analysts believe.
Most energy agencies, including the U.S. Energy Information Administration and the International Energy Agency, predict world oil demand will fall by 1% to 2% this year, following a similar decline in 2008.
Chakib Khelil, Algeria's energy minister, said Tuesday there was a 50% chance of another supply cut during OPEC's next meeting on March 15, according to media reports.
But OPEC members, who control more than one third of the world's oil production, have a sketchy record of implementing production cuts.
Oil could rise if OPEC cuts production, said Phil Flynn, vice president at Alaron Trading. "But the problem is the compliance."

OPEC in January met only two-thirds of its pledge to lower oil output, as several members continued to pump above target levels, a Reuters survey showed on Tuesday.
While Saudi Arabia and the United Arab Emirates lowered their production below or close to their targets, some other countries, such as Venezuela and Iran, have pumped more oil than their allowed quotas, the survey found.
Economic rebound?
Investors are also hoping demand will rebound once the economy is revived. With governments worldwide adopting stimulus packages, some economists believe the economy could bottom out in the second half of the year.
The Federal Reserve said late January the economy was in worse shape than it was in December, but a "gradual recovery [...] will begin later this year."
And in its January monthly report, the Energy Department's EIA said that after two years' decline, world oil consumption is expected to record a modest rebound in 2010,.
Such forecasts have already encouraged oil investors to build up their positions, even before prices start rising.
"We are in a world of increasing demand and decreasing supply for tangible things, especially energy," said Steven Podnos, a financial advisor at Wealth Care LLC. "Oil represents an attractive investment sector."
But for now, the oil market is still plagued by weak demand and lofty inventories. The EIA reported Wednesday that crude inventories in the U.S., the world's biggest oil consumer, rose for a sixth straight week to 346.1 million barrels, the highest level in 18 months.
Meanwhile, inventories at Cushing, Okla., the delivery point for Nymex crude futures, have reached a new record high of 34.3 million barrels.
Global demand is poised to post the largest contraction this year since 1982, analysts at Morgan Stanley said in a recent report.
"Supply constraints will remain a longer-term issue and will be intensified by the current bout of weaker prices," the Morgan Stanley analysts said. But "the magnitude of demand weakness will leave this constraint a non-issue in 2009."
They expect oil prices to average $35 barrels in 2009 and fall to a low of $25 in the second quarter.
The EIA, meanwhile, said in its January report, it expects oil prices to average $43 per barrel in 2009 and $55 in 2010.

While oil prices should rise this year, it'll be interesting to see if we've really hit an oil futures low, or it takes more time to work out depending on consumer demand connected to the economic crisis.

Oil: OPEC Production Cuts

OPEC countries are under increasing pressure to cut oil production as oil prices aren't able to prop up the many countries so reliant on higher prices to take care of their needs.

It's not a stretch to say the leaders of oil producing countries will have their hands full as people start to get edgy over consequences of low prices.

In reality, there's not much OPEC and other oil producing countries can do about it, as the economic crisis has lowered demand for oil, and no matter how far oil production is cut, it's not going to get people to spend their money on gas they're not going to use.

Cutting oil production will only cause people to travel even less, undercutting the very strategy attempted by countries to prop up their crude prices.

If oil prices rise than there will be a high cost of oil that will sit there not being used, as people continue to save rather than spend their money.

Oil storage and reserves are growing while consumers hold back from buying, that isn't going to change for OPEC or oil companies. The oil industry can cut production, and it has already, but that won't solve the problem the market has already decided.

All that corporations and countries should do is get out of the way and let the market figure it out. Intervention into the oil market will cause unintended consequences as government interference always does, and only prolong the economic pain for everyone.

There is nothing driving the oil markets, prices, supply, costs, drilling and production other than consumer demand. Nothing can be done to change that until the economic crisis ends and then money flowing back into consumer goods and services.

The oil industry can only stand by and watch, cut cost, get leaner, and prepare for when the turnaround in the oil market comes.

This will be essential for the industry, as once demand rises, there will probably be a huge surge in buying as pent up demand explodes. Oil companies and refineries need to be ready for that time, as they'll soon forget the bad oil news of today and their profits will again surge ahead.

Oil exploration is another important factor in the mix, as there is plenty of oil out there, and the demand will come back stronger than ever as America, China and other nations will return to their insatiable appetites for oil that they had in the recent past.

So OPEC and oil companies just need to relax a bit. Yes there's problems related to low oil prices, but forcing the issue in attempts to artificially raise the price of oil above market levels never works.

We just have to wait out the tough times and wait for oil demand to rebound.

OPEC Export Revenue Dropping to Lowest Level in Five Years

Lower oil prices will cause export revenue for the Organization of the Petroleum Exporting Countries (OPEC) to drop to their lowest level in five years, according to the U.S. Energy Information Administration.

Most of the assertions of OPEC can only be taken with a grain of salt, as there's never full compliance by member nations, and the EIA confirms they're looking at only about half the projected cuts will in reality be made, which recently were decreased to a wishful 4.2 million barrels a day.

That leads them to project revenue for OPEC countries will be down by about $57 billion from last month's numbers, with overall revenue for the year reaching an estimated $387 billion.

Further out in 2010, there should be an increase to about $526 billion, still far below the $972 billion in revenue generated in 2008.

Taking into account the projections made when oil hit the record $147 a barrel during the summer, which were at $1.3 trillion for 2009, this is an extraordinary challenge for the OPEC countries which rely so much on the revenue to keep their countries stabilized.

Oil Prices Continue to Drop on Slowing Demand

Crude Oil for February delivery ended the session at $40.83, a decline of 87 cents, or 2.1 percent. Prices fell as low as $39.38 on the New York Mercantile Exchange during the day.

So far the announcements and compliance of OPEC nations in cutting production hasn't been a factor in determining the prices of crude. Demand continues to be the main driver of prices, rather than supply.

Many investors fled the sector Friday, fleeing from energy companies in droves.

Energy sector watchers now think the announcement of oil service behemoth Schlumberger (SLB) that they are going to cut 1,000 jobs in the U.S., along with overseas workers as well, is the beginning of further cuts in the industry. Halliburton (HAL) also said they're going to be laying off workers too.

To add fuel to the fire, Chevron (CVX) issued a warning today that their fourth-quarter results were going to be "significantly lower" than the heady third quarter's results. While that's not a surprise, combining those elements together shook up energy investors today.

This is going to be the wave of the near term, and the companies are going to suffer dramatically in contrast to recent success.

Oil Plunges to Lowest Level in Four Years

Today on the New York Mercantile Exchange, oil fell to its lowest level in four years, dropping to $36.22 at the end of the trading day. That was a 9.6 percent or $3.84 plunge per barrel for January delivery.

While trading volume was higher for February, it still fell $2.94 to finish the session at $41.67 a barrel on the NYMEX.

OPEC is of course panicking at the potential unrest that will inevitably come if prices continue to fall, and so cut production by another 4.2 billion more barrels a day on Wednesday, but that hasn't impressed traders much, as assertions and practical cooperation are two different things. Many countries say they'll participate in cutbacks historically, but full cooperation rarely, if ever, happens.

Price is the driving force behind the decline, as economic weakness is causing consumers to cut back on driving. If prices were to go higher at this time, consumers would simply cut back more. It's not a good time for OPEC, and it could become an even more dangerous situation going forward in a number of the countries that are part of the organization.

It'll be difficult to develop a supply/demand balance going forward, as economic uncertainty and the unknown continue to hamper stability. Whenever that becomes stable, the price range is expected to flucuate by around $15 a barrel.

January gasoline on Globex also moved down with oil, as prices drooped 5 cents to finish at 92 cents a gallon. Heating oil followed suit, ending down by 7 cents to $1.37 a gallon.

Platts Survey: November OPEC Oil Output Fell to 31.38 Mil. Barrels Per Day

LONDON, Dec 09, 2008 /PRNewswire via COMTEX/ -- Platts -- The 13 members of the Organization of the Petroleum Exporting Countries (OPEC) pumped an average 31.38 million barrels per day (b/d) of crude oil in November, according to a Platts survey of OPEC and oil industry officials just released. This is a decline of 880,000 from the October level of 32.26 million b/d.

Excluding Indonesia, which will leave OPEC at the end of this year, and Iraq, production from the 11 members bound by output agreements fell by 950,000 b/d to 28.16 million b/d from 29.11 million b/d, the survey showed.

This leaves the OPEC-11 with an additional 852,000 b/d of supply to remove if they are to reduce output to the level of the 27.308 million b/d output limit which came into effect at the beginning of November after the group agreed to slash production by 1.5 million b/d at emergency talks in Vienna on October 24.

"These cuts are nowhere near what analysts estimate is needed for OPEC to slash simply to catch up with rapidly receding demand," said Platts Global Director of Oil John Kingston. "Even if the full 1.5 million b/d cut was implemented, few now think even that would be enough to stave off tremendous increases in inventories, which will push prices down further. OPEC will have its work cut out for it at its upcoming meeting, with two main agenda items: how do we get to the cuts we agreed upon in October, and how much further do we cut from there?"

OPEC powerhouse Saudi Arabia accounted for the biggest single reduction, cutting its output to 8.9 million b/d from 9.4 million b/d in October. This leaves the kingdom still pumping more than 400,000 b/d in excess of its new 8.477 million b/d quota.
Kuwait and the United Arab Emirates (UAE) reduced output by 100,000 b/d and 150,000 b/d respectively, UAE output had been expected to decline as a result of field maintenance. Nigerian output fell by 50,000 b/d to 1.9 million b/d after new attacks on oil installations by rebels in the Niger Delta. Other smaller reductions came from Iran, Libya, Qatar and Venezuela.

Output from Angola, Ecuador and Indonesia was unchanged from October levels.
Iraqi volumes increased to 2.37 million b/d, reflecting largely higher exports from the south as well as an increase in internal consumption.

OPEC ministers are scheduled to meet on December 17 in Oran, in western Algeria, where several ministers have said an additional output cut will be on the table for serious consideration.

Oil prices have plunged by more than $100 per barrel in just five months, falling from record highs of more than $147/b in early July to under $40 per barrel last week.

Although some forecasters, including the International Energy Agency and OPEC, still see some growth in world oil demand next year, others, such as the Centre for Global Energy Studies in London and Wood Mackenzie in Edinburgh, see demand contracting in 2009.

* From November 1. Indonesia, which will leave OPEC at the end of the year, is not part of the October 24 decision to reduce the target by 1.5 million b/d to 27.308 million b/d. Previous totals have been recalculated as OPEC-11 totals to exclude Indonesia.

For production numbers by country, a table is available at http://www.platts.com/Oil/Resources/News%20Features/opec/prod_table.xml.
More information on OPEC is available via "Platts Guide to OPEC" at http://www.opec.platts.com.

About Platts:

Platts, a division of The McGraw-Hill Companies (MHP) , is a leading global provider of energy and commodities information. With nearly a century of business experience, Platts serves customers across more than 150 countries. From 17 offices worldwide, Platts serves the oil, natural gas, electricity, nuclear power, coal, emissions, petrochemical, shipping and metals markets. Platts' real time news, pricing, analytical services, and conferences help markets operate with transparency and efficiency. Traders, risk managers, analysts, and industry leaders depend upon Platts to help them make better trading and investment decisions. Additional information is available at http://www.platts.com.

About The McGraw-Hill Companies:

Founded in 1888, The McGraw-Hill Companies (MHP) is a leading global information services provider meeting worldwide needs in the financial services, education and business information markets through leading brands such as Standard & Poor's, McGraw-Hill Education, BusinessWeek and J.D. Power and Associates. The Corporation has more than 280 offices in 40 countries. Sales in 2007 were $6.8 billion. Additional information is available at http://www.mcgraw-hill.com.

SOURCE Platts

http://www.mcgraw-hill.com

Copyright (C) 2008 PR Newswire. All rights reserved

Global National Oil Companies Look for Oil to Drop to $40 a Barrel

National oil companies from around the world said in a recent meeting in Beijing that prices would probably fall to around $40 a barrel, according to Fu Chengyu, chief executive of China National Offshore Oil Corporation.

Fu added that the tone of the meeting was one on the verge of panic, as the reality of what is happening with oil is setting in.

Commenting on the idea of OPEC to cut back more on production, Fu said that it probably won't have any significant impact on the price of oil. The major reason for that is the economic climate around the world, which is making oil nowhere near the priority of consumers, who have cut back on travel and vacationing, and are spending only on necessities.

Another outcome of this is oil companies will cut back on investing in new projects, as the current and eventual price of oil can't sustain them.

Most extraction projects were initiated assuming a minimum price of $60 a barrel to break even, and up to $90 a barrel.

“When most of the oil companies budgeted their projects, they were using $70, $80, even $100 a barrel for their cash flow calculations,” Fu said. “For those projects that have started, certainly they will try to complete them, but for those projects that have not started yet they will delay or cancel. Simply, they don’t have enough cash to do all of those that they budgeted.”

OPEC Could Cut Production by 1 Million Barrels in Cairo

Fighting to stave off oil plunging below $50 a barrel, OPEC may cut production another 1 million barrels a day.

Expectations are at the next OPEC meeting on November 29 they will definitely cut production again, the question is only by how much. The 1 million barrels a day figure is expected by most analysts; although some have said it could be anywhere from 500,000 a day to 3 million barrels a day.

The problem from OPEC's standpoint is it's one thing to announce production cuts, it's another thing to implement them, as supply cut announcements from September and October are still in the process of being put into action.

Iran is calling for cuts between 1 to 1.5 million barrels a day.

Oil futures closed Friday's session down to $57.04 a barrel for December delivery on the Nymex.

Oil Falls Almost 6 Percent Monday, as Demand Drives Prices Down

OPEC, other oil producers and oil companies, at this time must sit on the sidelines and watch, as oil prices are being driven by only one thing at this time, and that is demand; and demand is continuing to decline.

What is driving demand is fears of consumers on the condition of the economy, and that has them holding their cash close to their chests.

Confirming this even more was the level of factory activity in the U.S., which has been the key indicator on the demand for oil. That dropped sharply in October, down to its lowest levels in 26 years.

With the Institute for Supply Management saying factory activity in the U.S. dropped to 38.9 for October, it underscored the deep cutbacks experienced in the sector. Anything under 40 is considered a very weak performance. The month of September came in at 43.5.

For the last several weeks, U.S. demand for oil has fallen off by about 2 million barrels a day.

Crude in the U.S. fell 6 percent to $63.91 a barrel, a drop of $3.90. London Brent Crude fell even more, finishing the session at $60.49 a barrel, a decline of $4.84 a barrel.

Weak Demand Driving Oil Prices Down, Not Supply

While OPEC Secretary-General Abdalla el-Badri said the leaders of countries will definitely get together again if the recent daily cut of 1.5 million barrels in oil production doesn't curb plunging prices, it won't really matter, as it's not supply driving prices down, but demand.

Jittery consumers will continue to cut back on driving and traveling in response to the credit crisis and economic weakness.

"Until you see a change in economic sentiment, there won't be any sustained rallies in the oil market," said Kyle Cooper, an analyst at IAF Advisors in Houston. OPEC "can announce all the cuts they like and the market will ignore it."

Even if there is another meeting and decisions made to drop daily production more, it's doubtful all the countries would be willing or able to comply with the agreement anyway, which would do more harm to OPEC than help, as it would make it look even more desparate.

A number of OPEC countries are in great need for cash just like most countries around the world.

Gasoline usage dropped again last week, falling by 6.4 percent from the same period a year ago. Declining prices at the gas stations did nothing to jumpstart demand.

Crude oil closed down 49 cents today for December delivery, settling at $62.73 a barrel on the New York Mercantile Exchange.

In after-hour trading it rebounded some to $64.37 a barrel at about 4:00 EST.

On the London Ice Futures Europe exchange, Brent crude fell another $1.12, to settle at $60.29 a barrel.

Crude Oil Prices Continue to Fall off the Cliff: Now at 15-Month Low

In intraday trading crude oil fell of the cliff again, plunging by over $4 a barrel - a 15-month low. The continued fall in oil prices is completely tied to consumer demand, which has dropped as people cut back on spending on anything but essentials.

December delivery for crude oil dropped by $4.25 to $67.93 a barrel shortly after 11:00 a.m. EST today on the NYMEX. Oil futures hit a low of $67.50, the worst showing since June 27, 2007.

On London's ICE Futures Europe exchange, Brent crude has dropped by $3.40 for the December settlement, a 4.9 percent fall. It now stands at $66.32 a barrel. That's the lowest price since May 10, 2007.

For the week ending October 17, fuel demand in the U.S. averaged 18.7 million barrels a day, according to the report of the Energy Department released today. That's down 8.5 percent from the same period last year.

Average use of gasoline has also fallen, now averaging 8.8 million barrels a day for the last four weeks, down from last year by 4.3 percent.

With distillate fuel (heating oil, diesel) use also dropping significantly, we can see demand for oil will continue to fall for some time.

Even though the unprecedented special meeting by OPEC next month is expected to result in the cutback of 1 million barrels a day in production, that will do nothing to change the demand factor until the global economy recovers. That isn't going to happen any time soon.

Part of the result of all this will be less travel, which will affect not only oil companies, but airlines and shipping companies as well.

Oil inventories also continue to rise, as there was an increase of 3.18 millon barrels to 311.4 million barrels, the fourth time in a row.