U.S. Fracking Shatters OPEC Oil Cartel | LifeZette

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U.S. Fracking Shatters OPEC Oil Cartel

You're welcome, world: American ingenuity sends oil price plummeting

The peak oilers — those who thought production was going to top out and then decline — were wrong. Instead, American ingenuity and persistence has broken the back of OPEC.

Last fall, the United States produced about 9.4 million barrels per day of crude oil — an increase of some 75 percent in just the past five years.

The U.S. has not produced this much oil since the 1970s. The oil exporting countries noticed.

Virtually all of this new production comes from unconventional production. Hydraulic fracturing, directional drilling, 3-D seismic mapping and a host of other smart drilling technologies have opened up vast amounts of previously uneconomic oil and gas reserves — primarily in shale. It’s an American-made energy renaissance, and its effects go way beyond $2 gasoline at the corner station.

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More than a year ago, Saudi Arabia realized the U.S. shale revolution meant they could no longer control oil prices. If they cut their production in an attempt to force world prices higher, it would lead to even greater production in the U.S. Any Saudi-led price increase would be short-lived and ultimately result in a reduced Saudi market share. So, Saudi Arabia decided to open the spigot and let market forces adjust production elsewhere.

Since the other members of OPEC never have had any stomach for cutting their own production, the Saudi decision means OPEC is pumping at full throttle — at least as full as war, sanctions and too-often incompetent management allow. This is good for oil consumers and, in the long run anyway, good for the world economy. However, it isn’t good for the budgets of OPEC members and their allies.

According to an analysis done last month, two-thirds of OPEC members need an oil price of at least $80 per barrel to balance their budgets. None can do so with the current prices of around $30 per barrel. Maybe governments of oil exporters that fund troublemakers in other parts of the world will find such expenditures are no longer a priority.

Something will have to change.

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Predicting oil prices is a dicey business. Among those who dare, few predict a return to $80 oil anytime soon. In fact, many forecast further declines to $20 per barrel, and a brave few see $10 oil in the near future. So, major oil exporters may experience even tougher times ahead.

Of course, low prices hurt oil producers everywhere, including in the U.S. In the jargon of economics, the demand for oil is inelastic. This means that an increase in the supply of oil will drive prices down by an even larger percent, leading to lower total revenue for the sellers.

The price will drop until some producers can no longer cover their expenses and shut down production. The question is: Who goes first, and at what price level?

A popular narrative casts this as a battle between Saudi Arabia and the U.S. shale-oil producers. But, it’s more a case of everyone against all as markets adjust to the new reality of a U.S. oil resurgence compounded by softening of the Chinese economy.

No oil producers are immune from low prices. The 70 percent drop of the past two years dramatically reduced the amount of drilling in the U.S. and caused total output to level off. The corresponding lower profits will almost certainly lead to a shakeout in the oil and gas industry. However, Mark Mills, a senior fellow at the Manhattan Institute, notes that rig counts no longer mean as much as they used to and that the stunning efficiency gains may continue to offset lower prices.

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Where the bottom of the cost curve will end up is anybody’s guess. But the costs of production in many parts of the shale patch are much lower than people would have predicted a couple of years ago. These new, lower costs beat those of some of the oil exporting countries. Many of these oil exporters have such a dependence on export revenue that current prices may well cause political problems for regimes that have been using oil money to paper over the impact of their bad policies.

No one knows how everything will pan out. What we do know is that OPEC is no longer cracking the world’s energy whip. For that, we can thank American capitalism and its can-do spirit.

David W. Kreutzer is the senior research fellow in energy economics at The Heritage Foundation’s Center for Data Analysis.

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