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OPEC’s Cheap Oil Is About To Crush The U.S. Oil Boom (For Now)

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Grant Smith, Bloomberg

After a year suffering the economic consequences of the oil price slump, OPEC is finally on the cusp of choking off growth in U.S. crude output.

The nation’s production is almost back down to the level pumped in November, when the Organization of Petroleum Exporting Countries switched its strategy to focus on battering competitors and reclaiming market share. As the U.S. wilts, demand for OPEC’s crude will grow in 2015, ending two years of retreat, the International Energy Agency estimates.

While cratering prices and historic cutbacks in drilling have taken their toll on the U.S., OPEC members have also paid a heavy price. A year of plunging government revenues, growing budget deficits and slumping currencies has left several members grappling with severe economic problems. The fact that the U.S. oil boom kept going for about six months after the group’s November decision also means OPEC has so far succeeded only in bringing the market back to where it started.

“It’s taken a hell of a long time and it will continue to take a long time — U.S. oil production has been more resilient than people thought,” said Mike Wittner, head of oil markets research at Societe Generale SA in London. “The bottom line is the re-balancing has begun.”

OPEC abandoned its traditional role of paring production to prevent oversupply last November as a tide of new oil from the U.S. eroded its share of world markets. The group chose instead to keep pumping, allowing the subsequent price slump to squeeze competitors with higher costs. Its representatives will meet in Vienna Wednesday with non-member countries including Russia for technical talks.

Shrinking Shale

The plan appears to be working. Oil remains 33 percent lower than when OPEC revealed its strategy on Nov. 27, trading for $48.42 a barrel at 8:05 a.m. in London Wednesday. U.S. crude production has retreated about 500,000 barrels a day from the three-decade peak reached in June to 9.1 million a day in the week to Oct. 9, according to data from the Energy Information Administration.

The losses will accelerate next year with a drop of 390,000 barrels a day in annual average production to 8.86 million barrels a day, according to the EIA. OPEC’s fortunes will improve as the U.S. declines, with the IEA predicting demand for the group’s crude climbing to 31.1 million barrels a day next year from 29.3 million in 2014.

“Their strategy is still working for them,” said Miswin Mahesh, an analyst at Barclays Plc in London. “It means pain now, but in the medium-to-long term they will reap the fruits of a more balanced market, moderated shale supplies, growing demand for oil and ultimately a higher price.”

Fragile Economies

The pain has been considerable. The average price of a selection of OPEC’s crudes has been about 46 percent lower this year than in 2014, equivalent to a loss of export earnings of roughly $370 billion.

Saudi Arabia, the main architect of OPEC’s new strategy, will have a budget deficit of 20 percent of gross domestic product this year, the International Monetary Fund estimates. While the kingdom has been able to tap foreign currency reserves and curb spending to cope with the slump, financial assets may run out within five years if the government maintains current policies and prices stay low, the IMF said Wednesday.

Less wealthy OPEC members have even fewer options. The threat of political unrest is mounting in the “Fragile Five” of Algeria, Iraq, Libya, Nigeria and Venezuela, according to RBC Capital Markets LLC.

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