The reason oil prices have come down is because OPEC has cut prices arbitrarily. They were artificially high to begin with. On average it costs an OPEC nation ~$30 to produce a barrel of crude. They're still making a shitload of profit.
It's not arbitrary at all, and it's not really OPEC, as many OPEC members would rather see higher prices for their own internal political reasons. The primary driver is Saudi Arabia, who is trying to crush the shale oil producers in the US (particularly, and to some extent Canada) where oil cannot be produced at profit for less than $80 a barrel. A sustained price below that point is
intended to chase US firms out of the market, as they can't produce profits at this level, which in the long-run would be good for Saudi Arabia.
Prices aren't "set" in that way. It is primarily a global auction market price, with some lesser side-deals.
What the OPEC countries do is set and publish production targets for themselves. Sometimes they also violate these targets and release more oil than they say that they will behind the backs of the cartel partners.
To say what is "intended" by them is essentially a bizarre claim of mind-reading. There may well be other intentions entirely, (such as maintaining the largess of their regime and thus forestalling a democratic revolt) and the effects on USA and Russia may be merely side effects and unintended consequences, or even simply not as big of a factor as other financial concerns of selling enough oil as they feel that they need to sell.
Not all effects of actions are controlled. Even children know this the first time they accidentally break something.
Mate, I'm not saying they're "set" at all. It's a function of supply and demand. I'm referencing the financial trade papers on the topic, like WSJ or Bloomberg who report that there's an oversupply of oil brought on by the shale production in the US. (US oil production has doubled since 2008 due to fracking.) Traditionally, when there is an oversupply, OPEC cuts back to keep the price elevated, and although most of the OPEC members want to cut back, Saudi Arabia (the largest oil producer in the world) has announced they will not be cutting production due to price declines. This has caused the price of oil to drop to the lowest point in 5 years because it means the oversupply is not going to be addressed. Saudi Arabia is doing this intentionally because shale oil is expensive to produce, and the state-run Saudi oil companies can stomach losses longer than American firms, who have to answer to shareholders who have no will to absorb losses for a sustained period of time. As an added bonus, low oil prices hurt Iran, a regional rival politically and militarily.
Here's an article published a few days ago about the oil blinking contest between the US and Saudi Arabia:
In the high-stakes contest between the United States, the biggest shale oil producer, and Saudi Arabia, the biggest oil exporter, America has blinked first.
The OPEC refusal to cut production at its November meeting was widely seen as the declaration of a price war against booming U.S. shale oil producers, which had sent their country’s oil production soaring. Saudis had watched as their market share dropped precipitously in the world’s biggest oil-consuming nation, and they wanted to send a clear message across the global energy market that they weren’t about to back off.
Oil prices have been in freefall ever since. Brent crude, the global oil benchmark, sank another 3 per cent Friday to $61.85 (U.S.) a barrel, while West Texas intermediate, the U.S. benchmark, dropped 3.6 per cent to $57.81, extending its slide from well over $100 a barrel in the summer.
If the global oil standoff pits the industry stalwart Saudi Arabia against the surging U.S. rival, other global players are coping with the pricing fallout, including Canada. Oil companies around the world are being forced to revisit their spending and production plans for 2015, and in the offices towers of downtown Calgary, those changes are already well under way.
Cenovus Energy Inc. this week slashed its capital budget by 15 per cent and signalled more to come. Canadian Natural Resources Ltd. has said a quarter of its $8.6-billion (Canadian) budget is “flexible” and could be deferred if prices don’t recover. A growing number of smaller producers have cut budgets and dividends in a bid to conserve cash and ride out the storm.
More cutbacks are likely to follow in the weeks ahead, and expectations that Alberta could double oil sands production over the next decade are suddenly in doubt. After all, new oil sands projects on the drawing board have costs per barrel well above current market prices.
For Canada, future projects sidelined or scaled back will act as a drag on the national economy, which has for years benefited from heavy spending in the energy sector while other sectors such as manufacturing struggled. The case for the many new pipelines currently in various stages of planning will be weakened.
Analysts warn it could take many months – even a full year – before global oil supplies fall enough and demand catches up, so that prices recover somewhat.
The oil slump is expected to affect most quickly on production levels in the United States, where the shale boom has added four million barrels a day of supply in the past few years and prompted predictions that the country would become the world’s largest crude producer by 2016.
Already, the number of new shale drilling licences has dropped by 40 per cent, plans are being scaled back, and rigs are being pulled out of the field. With relatively short lead times from planning to production, analysts are cutting their expectations of supply growth for next year. As Saudi Oil Minister Ali al-Naimi predicted two weeks ago, the market is beginning to “stabilize itself.”
But it will take a while for the Saudi strategy to play out. American producers are still expected to continue to boost production through the first half of next year, although at a slower rate than 2014. Meanwhile, global demand growth is slowing. That will keep pressure on prices at least through the first half of 2015, unless OPEC does cut production or there is a sharp supply disruption caused by political upheaval.
Companies adjust
On Friday, the International Energy Agency shaved its forecast for 2015 demand by 230,000 barrels a day – the fourth time in five months that it has reduced its forecast – citing economic weakness in Russia and China. The Paris-based agency also raised its expectation for non-OPEC oil production in 2015, despite lower prices.
Oil companies are seeing their revenues nosedive, share prices sink, and capital market players grow wary about lending. State-owned companies are facing pressure to maintain the flow of revenue to government coffers even as their cash flow dries up. Capital discipline had been the mantra among major oil companies heading into 2014; retrenchment and focus on high-grade prospects will be the watch words as the year ends.
Even as U.S. producers respond, companies operating in high-cost, capital-intensive areas like Canada’s oil sands or Brazil’s offshore will defer and even cancel planned projects, although the impact on actual production will take longer to materialize.
It’s too early to call “mission accomplished” for the Saudis. The OPEC leader is playing a long game in order to preserve its oil market share by making life difficult for the high-cost oil producers, and its strategy is showing early signs of success.
The quick reaction time by some of the high-cost producers, notably the American shale oil drillers, is why one of the world’s foremost oilmen, Sadad Al-Husseini, the former executive vice-president of Saudi Aramco, the world’s biggest oil and gas company, is becoming bullish on oil even as Brent prices sink to the low $60s.
“If you go down low enough, as we are now, you’ll get to the point where there is little investment, which is what we’re going through,” he said in an interview in Al Khobar, the Saudi city filled with Aramco employees in the country’s oil-rich Eastern Province. “You will force the excess out of the market and demand will take you back up. That is what is about to happen.”
‘Strength of the profit motive’
Mr. Al-Husseini, 67, worked at Aramco until his retirement in 2004 and was a member of its board and its management committee. During his Aramco career, he was instrumental in making 20 discoveries, including vast gas fields and the central Arabian and Red Sea oil fields. He is now president of Husseini Energy, an oil consultancy based in Bahrain that advises financial institutions and the oil services industry.
He admits he underestimated the “strength of the profit motive” that turned the United States into a shale oil powerhouse. Since 2010, U.S. shale oil production is up by three million barrels a day. But he feels confident that waning investment is already hitting production growth and that prices won’t fall much farther as the supply-demand balance tightens up.
“When prices come down 40 per cent, you’re not going to keep spending like there is no change,” he said. “My guess is that by the end of second quarter of 2015, there will be a returning confidence in oil. Does that mean it will go to $115? No, that was never a sustainable number. Could it go as high as $80, maybe $90? Sure.”
Unlike some of their more vulnerable OPEC partners like Venezuela and Nigeria, the Saudis can afford to be patient and wait for the market to recalibrate. But it too faces fiscal pressure as it spends heavily to diversify its economy and provide social benefits to a young population. The International Monetary Fund estimated early this year that Saudi Arabia needed an oil price of $89 (U.S.) a barrel to keep its budget out of the red, up from $80 in 2012.
U.S. shale oil is generally far more expensive to produce than Saudi oil, which has the lowest pumping costs in the world. Shale oil wells deplete rapidly, meaning a lot of them have to be drilled constantly to keep production intact.
The upshot? Shale oil output is much more sensitive to falling prices than Saudi oil, and the market is beginning to work its magic. Although the U.S. rig count remains well above the level of a year ago, it saw its biggest drop in two years this week and has declined in six of the past nine weeks. And it’s expected to drop sharply next year.
Estimates of break-even costs for new production in the three key shale basins – the Bakken, Eagle Ford and Permian – range from $60 to $70 a barrel. But there is wide discrepancy in the actual break-even costs for each well, and companies will focus spending on their best prospects.
“Balance sheets are going to force discipline,” said David Pursell, an analyst at Tudor Pickering & Holt Co. in Houston. “When we look at basin economics, there’s just a handful of core areas that make economic sense to continue to drill at even $70 crude. ... Companies will drop rig count very quick to stay within cash flow so they don’t see their balance sheets unravel. And they can unravel very quickly if they maintain the current activity level into 2015 at a much lower oil price.”
Most vulnerable are the smaller exploration and production (E&P) companies that have taken on debt as their spending outpaced their cash flow, and Mr. Pursell said the high-yield debt market on which they rely is already showing signs of nervousness. Companies like Range Resources Corp. and SandRidge Energy fall into that category.
The Tudor analyst sees the rig count dropping by nearly a third from the recent 1,600, but said it will still take several quarters before production growth slows. He predicts U.S. production will rise by 592,000 barrels a day next year and 226,000 in 2016, after growing by nearly one million barrels a day this year.
In a release Friday, the U.S. Energy Information Administration also indicated it will take time for the impact of lower prices to be felt in the supply picture. The EIA forecast that U.S. production will average 9.3 million barrels a day in 2015 – up from 8.6 million in 2014 and closing in on Saudi’s estimated 9.60 million daily output.
Mr. AL-Husseini is no fan of the theories that the decision by OPEC (read: Saudi Arabia) not to trim the cartel’s 30-million– barrel-a-day production quota at its November meeting in Vienna was a political act of war aimed at punishing Russia and Iran for their support of the al-Assad regime in Syria or aimed solely at choking off U.S. shale production.
He said it was a market decision designed to trim high-cost production wherever it lies, including Brazil’s offshore fields and Canada’s oil sands, to end the oil glut. An OPEC production cut would have only propped up prices, he noted, “subsidizing the high-cost oil at the expense of low-cost oil,” the latter being Saudi Arabia and Gulf allies such as Qatar.
Among the high-cost producers, there is no doubt that U.S. shale oil would be quickest to trim investment and thus output. Mr. Al-Husseini said that, even if oil prices were to remain fairly strong, the shale industry’s ability to deliver ever-higher production would not be assured. That’s because shale wells are short-lived creatures. His research says that shale oil (and natural gas) wells decline at a rate of 50 to 70 per cent a year, “requiring intense capacity replacement drilling.”
That means shale fields require more and more drilling to maintain production and that gets expensive. At the huge Eagle Ford shale field in southern Texas, some 4,500 new wells will have been drilled in 2014, of which 3,800 are required just to maintain production.
One major test for producers will be the degree to which they can squeeze costs out of the supply chain, thereby lowering their break-even price.
U.S. shale producers say they are doing just that. Houston-based EOG Resources Inc. has slashed the average well cost in North Dakota’s Bakken play to $8.7-million from $10.5-million two years ago. In the Eagle Ford, it reduced the number of days to drill a well to 12.5 from 22.7 in 2012.
Pioneer Natural Resources Co. said last week that it was still planning to pursue production growth of between 16 and 21 per cent next year, with its key assets in the West Texas Permian basin. Pioneer chief executive officer Scott Sheffield said the Saudis had “declared war on the U.S. oil and gas industry,” and the company is responding by driving down costs and re-evaluating its drilling program. He acknowledged that a sustained period of prices below $60 a barrel could force further cuts.
The oil sands challenge
But high-cost producers across the globe are facing similar challenges.
London-based oil economist Amrita Sen said Canada’s oil sands remains the world’s highest-cost production in terms of new projects, with the U.S. shale and the offshore in Mexico and Brazil not far behind.
Existing oil sands operations aren’t likely to be cut off any time soon. Analysts say currently producing projects have average per-barrel costs in the mid-$50s to mid-$60s, depending on the type of operation. “The advantage that oil sand producers have over, for example tight oil producers, is that they typically invest for the longer term as they rely on a steady stream of production over an extended period of time, making them less susceptible to temporary price fluctuations,” Ms. Sen said in a report this week.
Cenovus, for example, is slowing spending on longer-term projects that are still in early development stage, including Narrows Lake, Telephone Lake and Grand Rapids, while it continues to advance its Foster Creek and Christina Lake projects that are closer to completion. Under that capital plan, its production won’t be affected by today’s lower price until five years from now.
The same is true for most deep-water offshore fields, where companies may defer exploration or delay sanctioning new projects, but are unlikely to reverse course on those that are under development. Still, lower revenues will force an industry-wide cutback on activity.
Ms. Sen said the seeds of another cycle are now being planted. The current drop in prices will lead to lower-than-expected production in a few years, even as consumers increase consumption. U.S. gasoline demand is climbing at a rate well above its recent five-year average. And that classic supply-demand response could trigger a snap-back in prices in two or three years.
At the moment, though, “it’s hard to say anybody that relies on oil prices wins when prices are below $60 instead of $100 plus,” said R.J. Dukes, senior analyst with the Wood Mackenzie consultancy.
The oil slump is giving Canadians a long-awaited break at the pump, but is a worry for the country’s energy future. Since new oil sands projects are expected to have per-barrel costs of $80 or higher, they may no longer make sense, and the country may need to look to other sectors for new economic drivers.
