It Looks like OPEC Might Be Winning its Price War Versus U.S. Shale

Oil Price ForecastThe Organization of Petroleum Exporting Countries (OPEC) might finally be winning the oil price war, which could mean big things for the oil price forecast.

While the oil market may not see a balance between supply and demand until well into 2016, oil supplies might already be substantially declining.

The Energy Information Administration (EIA) announced last week that U.S. oil production levels saw significant cuts since the 9.6 million barrels per day peak in April. (Source: EIA, last accessed September 14, 2015.) The report confirmed that American crude output fell by 140,000 barrels per day last month, in an accelerating process of month-to-month declines since April. The latest weekly data announced by the organization shows that U.S. production stands at just 9.1 million barrels per day, though this is less accurate than monthly data. (Source: EIA, last accessed September 14, 2015.)

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Other leading industry organizations are echoing this sentiment. The International Energy Agency (IEA) reported on September 11th that its forecasts show a staggering 400,000 barrels per day reduction in U.S. production for 2016. (Source: IEA, last accessed September 14, 2015.)

Indeed, the IEA is beginning to publicly admit that OPEC’s year-long strategy appears to be working. (Source: CNBC, last accessed September 14, 2015.) The oil cartel had originally set out on a plan to eliminate higher-cost rivals by aggressively upping the ante with more production, touching off a price war which has led to today’s supply glut and oil price collapse. Saudi Arabia in particular wanted to avoid the nightmarish scenario it faced in the 1980s when it lowered production to lift oil prices, only to lose market share in the process.

The proof is in the pudding, as they say. And the numbers certainly match the IEA’s assertion. (Source: The Wall Street Journal, last accessed September 14, 2015.) Non-OPEC production is steadily declining, most notably the U.S., which alternatively vies with Russia and Saudi Arabia for the world’s top oil producer position. OPEC production is remaining at record levels with no sign of respite. (Source: OPEC, last accessed September 14, 2015.)

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The result has been the slow culling of high-cost or simply inefficient producers, just as OPEC had intended. Production in Texas’ Eagle Ford (Source: Eagle Ford Shale, last accessed September 14, 2015) and in the North Sea (Source: Bloomberg, last accessed September 14, 2015) have been throttled back significantly, and more cuts are to come.

This could lead to an additional reduction of 500,000 barrels of oil per day, which goes a long way to whittling away the two million barrels per day oversupply which is causing current woes. (Source: Financial Times, last accessed September 14, 2015.)

The transitionary period from high to low oil prices has been hard for all producers, OPEC included, but it looks like the cartel’s strategy will work.

Global crude oil supplies will slow down, while demand may begin to start growing. Indeed, oil demand is at a five-year record high, and is being forecasted to grow by 1.7 million barrels per day by the end of 2015. (Source: Business News Network, last accessed September 14, 2015.) Demand for OPEC’s oil may rise to 32 million barrels per day by the end of 2016, its highest level since the period before the financial crisis.

To put that into perspective, consider that total OPEC production in August was approximately 31.6 million barrels per day. (Source: OPEC, last accessed September 14, 2015.) If OPEC does succeed at driving rival producers into the ground, it will be in a position to cash in on a massive oil price surge.

If these forecasts are correct, with supply contracting and demand surging, the current oversupply may be eliminated by the end of next year.

But it gets more complicated. The IEA asserted that given the current trend of non-OPEC production slumping downward, demand growth will have to be matched by OPEC supplies. In an ironic twist of fate, OPEC producers would have to operate at peak efficiency to avoid a slight market shortage. Since a shortage would bring about a spike in prices and allow rivals to re-enter the market, this is something it wishes to avoid at all costs.

What Does This Mean for the Oil Price Forecast?

Things aren’t looking too great for oil prices in the short term. Global oversupply continues, with demand lagging behind a glut of supply. Stockpiles of crude oil and refined products continue to rise. The EIA reported that U.S. storage levels rose again last week, to the tune of 2.6 million barrels. (Source: EIA, last accessed September 14, 2015.) Though hopes had been pinned on a drawdown coming from record summer driving levels, this is now grinding down as we go into fall refinery maintenance season. Total U.S. storage is now back to its highest point since July.

While the $20.00 per barrel of oil price suggested by Goldman Sachs last week may seem too bearish to some, the fundamental imbalance in the oil market certainly doesn’t discard the possibility. (Source: Forbes, last accessed September 14, 2015.) What is almost certain from the report is the assertion that oil prices will have to drop down further, forcing some producers out of the game, before the necessary changes happen in the energy sector for crude oil prices to rise.

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