By Clifford Krause, The New York Times, April 22, 2015
|Saudi Arabia's Oil Minister Ali Al-Naimi talks to reporters at the conclusion of November 27, 2014 meeting of OPEC. Saudi Arabia prevailed to keep production quotas not to lose market share in face of cheaper U.S. oil.|
HOUSTON — For the better part of the last century, crude oil prices have swung like a pendulum, pushing and pulling the fortunes of nations. More often than not, global supplies of the volatile commodity were controlled by the rulers of desert domains who would otherwise have been powerless had it not been for the oil that bubbled beneath their thrones.
That pendulum is on the move again, sending the price of oil cascading to less than $45 this winter from more than $100 a barrel last June, and it may fall further in the months ahead. On the surface, this latest oil boom gone bust may feel like history repeating itself, but there is a vital difference this time: The center of the oil world has spun from the sands of Saudi Arabia to the shale oil fields of Texas and North Dakota, a giant new oil patch some wildcatters have begun to call “Cowboyistan.”
Put another way, the United States is overtaking the Organization of the Petroleum Exporting Countries as the vital global swing producer that determines prices. That remarkable change has been building since 2008, as American shale fields accounted for roughly half of the world’s oil production growth while American petroleum output nearly doubled. And shale production methods have proven highly adaptable to market conditions.
Not coincidentally, nearly all the advantages of the price swing are moving in Washington’s direction. Most American consumers and industries have benefited from a sharp drop in gasoline prices and other energy costs. And abroad, the economies of oil-producing adversaries like Russia and Venezuela are reeling.
Rene G. Ortiz, a former Ecuadorean oil minister who also once served as OPEC’s secretary general, noted that as recently as late 2008 and 2009, the last time oil prices slumped, OPEC cut oil production by four million barrels a day to support prices, and the move stabilized the market in a relatively short time.
“Why doesn’t Saudi Arabia think that couldn’t work again today?” Mr. Ortiz asked. “Because of the soaring U.S. production. Today’s OPEC is thinking about market fundamentals rather than manipulating the market because it doesn’t have the same power it once had.”
Last Nov. 27 was a turning point for OPEC at its meeting in Vienna. It was a turbulent session, though behind closed doors, where the firebrand oil ministers of Venezuela and Iran faced off with the dour Saudis and their Persian Gulf allies. The Venezuelans and Iranians, backed by Algeria, Nigeria and a few other countries that need every cent they can get from their oil exports, argued that OPEC should slash production to strengthen prices exactly as the cartel did when the crude price tumbled during the Asian financial crisis in the late 1990s, and again after the tech bubble popped in the early 2000s, and finally as it did again just six years ago.
But the Saudis and their Gulf allies said no. They argued that if they cut production, they would merely lose market share to the surging American producers who were increasing daily production by a million barrels year in and year out with no end in sight. The decision effectively forfeited the cartel’s traditional role as the global oil swing producer — the one and only supplier with the volume of production to raise and lower prices by managing the cartel’s output.
The decision came as a shock to the oil market. From the moment OPEC decided to keep its production constant at 30 million barrels a day, a fairly gradual price retreat that began in July morphed into a nose dive as commodity traders dumped their oil positions. Many independent American producers saw the move as a direct attack on them, but it was really a throwing in the towel to the new reality of growing American oil output.
The demise of OPEC as the price manipulator is what virtually every American president since Richard Nixon had in mind when they promised to find a way to make the United States energy independent, not chained to Middle East or OPEC oil, after the oil embargoes of the 1960s and 1970s.
Hydraulic fracturing, the blasting of oil and gas out of shale rock with water and chemicals, is the single most important factor of change in global markets in more than a decade, with an environmental outcry commensurate to its magnitude.
As soon as railroads connected North Dakota’s Bakken shale field to East Coast refineries the last couple of years, imports from the Middle East and Africa dried up, forcing various OPEC producers to redirect their product to China and other Asian markets. There, they battled it out for market share by slashing prices. That is just one example of how shale drilling not only transformed the United States from dependent consumer to a robust producer, but is also transforming the price dynamics of the global market.
Shale fields differ in several ways from conventional fields. Shale is not hard to find, but drilling is expensive because wells decline precipitously — by 60 to 70 percent in their first year. That means companies are obliged to drill well after well to keep production and revenue up.
That is not always good for individual producers, especially small ones, when prices fall. But those characteristics give shale producers collectively more power to influence the market because it condenses the amount of time companies have to respond to the inevitable cycles of boom and bust. Oil producers operating in the United States have the ability to rapidly accelerate or tap the brakes — much as Saudi Arabia and its OPEC partners have turned on and off their spare capacity in the past — depending on market conditions.
Jack Gerard, chief executive of the American Petroleum Institute, noted that the United States, which produces roughly the same amount of oil as Saudi Arabia and is poised to surpass the kingdom, is positioned to become the new OPEC but without the overt manipulation.
“The only difference is our position as swing producer will be managed by the free market,” he said, noting that a few all-powerful sheikhs are being replaced by hundreds of executives serving competing companies deciding when, where and how to drill in the new shale fields.
“With the technological advantages we have, we have the ability to adjust to the market,” Mr. Gerard added.
The Saudis, in comparison, are in an increasingly weaker position. Last year, their exports declined not only to the United States, but to Asia as well. Still, as one of the lowest-price producers with an expanding refinery capacity, it remains an important player on the world stage.
With Saudi Arabia leading, OPEC still controls roughly 30 percent of world oil production, but that is down from more than 40 percent in the 1970s. A reversal of that trend is not likely. (United States production now represents roughly 10 percent of global production.)
Jason Bordoff, a former energy adviser to President Obama and now the director of Columbia University’s Center on Global Energy Policy, noted that Saudi Arabia’s 2.5 million barrels of spare production capacity (over and above its roughly 10 million barrels a day of production) would continue to give it major influence on world markets, especially when prices are rocketing up as demand outstrips supply. It can still pump more to ease prices when it wants. But now with a global glut and prices cratering, he said, the United States was in the driver’s seat.
“The nature of U.S. shale production, which turns on and off so quickly and has the potential to provide a floor for the world oil price, can have pretty fundamental historic implications for how we think of the role of OPEC and Saudi Arabia versus the role of the U.S.,” Mr. Bordoff said.
Since the drop in crude prices began last year, the American oil industry has responded with remarkable speed, dropping more than half its oil rigs, from just over 1,600 late last year to fewer than 800 by April.
The transformation has not been without its share of pain. Oil companies have announced layoffs of more than 100,000 workers since November. But as large companies take advantage of bargain basement prices to gobble up the assets of weaker companies, he industry is likely to be better capitalized to expand production in the future.
The oil price has edged up in April but a full rebound could take years. In the short term, the West Texas Intermediate oil price benchmark may fall again as American storage facilities reach their space limit this spring. But the decelerating rate of American production growth is bolstering the hopes of commodity traders that the glut will dissipate faster than some extended price collapses of the past.
“The shale industry is now revealing itself as a nimble and price-responsive producer at a time when OPEC member-states have refused to squelch their own production, thereby rejecting their customary market-balancing role,” according to a recent study by Rice University’s Baker Institute for Public Policy.
The Energy Department has predicted that current United States oil production of 9.4 million barrels a day will decline by 210,000 barrels a day in the third quarter. Energy experts expect further declines into 2016 (accompanied by reduced production in some conventional foreign oil fields), and many executives are predicting that prices will stabilize at $70 to $80 a barrel over the next few years, a sweet spot where consumers get a break but companies can still profit because technology is making drilling cheaper.
The nation’s new ability to influence supplies and prices could only have been a dream in the Nixon and Carter days. Ample United States supplies in recent years protected the American economy while the Middle East and North Africa have been in turmoil, and it enabled Washington to spearhead sanctions on Iran without causing a price increase.
But just as the end of the collapse of the Soviet Union and the end of the Cold War did not usher in an era of peace and harmony, the new American energy security has not brought with it perfect stability. Analysts who suggested that energy independence would end the need for United States intervention in the Middle East did not see the coming of Islamist terrorism nor the spreading turmoil that has moved from Syria to Iraq and potentially beyond.
Foreign foes like Venezuela and Russia have been weakened by the falling price of oil, which dominate their economies. Iran may be willing to negotiate a deal to curtail its nuclear program to escape sanctions. But there is no sign that the Kremlin is less aggressive or dangerous. Falling oil prices should help the global economy, but deflation could be a risk in some nations.
Environmentalists argue that the worst thing about low prices for oil and other hydrocarbons is that they encourage more consumption. Lower gasoline prices have pushed up sales of sport utility vehicles and other large cars. Lower oil and natural gas prices are directly tied to the expanded production made possible by hydraulic fracturing, which is still considered risky by many environmentalists because of the escape of greenhouse gases into the atmosphere during exploration, production and transport, along with potential seepage of toxic fluids into water supplies.
“Having prices that reflect the environmental damage are better than low prices that don’t reflect that damage,” said Sonia Aggarwal, director of strategy at Energy Innovation, an environmental consulting firm in San Francisco. But, she added, “the advancement of technologies and the efficiency standards that the Obama administration has put in place for cars and trucks should make the lower oil prices less damaging than they would have been 10 years ago.”
President Obama has applauded the drop in gasoline prices, but he still straddles the interests of environmentalists with those of the oil companies when it comes to hot-button issues like offshore drilling and expanding exports of United States oil and natural gas. Nevertheless, he can be expected to use lower energy prices and the abundant domestic oil supplies as a reason for finally rejecting the Keystone XL pipeline intended to bring Canadian oil sands production to American refineries.
There is a strong chance, energy experts say, that this could be the beginning of decades of United States dominance in the oil markets, and that dominance will be accompanied by relatively inexpensive energy. The shale fields around the country are plentiful, and there is much more to be drilled. Lower prices have already driven down drilling and other service company costs by more than 15 percent.
But more important, the drilling and fracking technology that has made the shale revolution possible is rapidly improving, bringing production costs even lower and raising the yield of each well. For instance, more powerful computers are improving multidimensional geological modeling for well planning. And production output is improving through experimentation in the mixing and use of proppants like sand and ceramics to keep fractures in shale open to release more oil.
A recent Citi Research report noted that even when the rig count for natural gas collapsed in 2008 and 2009, production increased anyway, because companies cut costs while bolstering their yields.
Even if oil doesn’t exactly follow gas, United States oil production may still increase in coming years even as prices stay well below the $100 a barrel level of recent years. That could marginalize OPEC, and potentially make the United States a major oil exporter for the first time in more than half a century if Washington finally overturns some decades-old regulatory hurdles. Those memories of long car lines at the pump in the 1970s are becoming fainter. They may soon be forgotten.
“The Saudis are facing very challenging conditions as they face the future of the global oil market in part because shale does work at far lower prices than many people thought,” Mr. Bordoff said, “and U.S. shale production is going to keep growing as prices rebound.”