OPEC & Oil Price

A shift of focus

OPEC’s monthly oil market report will be closely analysed by traders and investors for changes in the members’ production levels. However, since Saudi Arabia’s decision not to support the oil price in 2014, focus has slowly shifted away from OPEC to the US, which has become the marginal producer of oil and gas as a result of discovering substantial shale reserves. US oil production exploded in 2010, peaking in June 2015.

US Oil Production

 

The boom in production stemmed from a rise in the number of wells in operation (the “rig count”) coupled with significant technological improvement in the Exploration and Production (E&P) space. An oil price of c.$100 made it profitable for many companies to drill, even for those with high marginal cost bases. However, in 2014 OPEC decided not to support these marginal shale producers by cutting its own production. The result was a collapse in the oil price from $100 to c.$30 which, in turn, led to a collapse in the US rig count.

Oil Price & US Rig Count

 

However, since the oil price found its floor of c.$30, the rig count has begun to pick up again, which in turn has led to a fall in the oil price from mid-May.

US Oil Price & US Rig Count (Inverted)

The high correlation between the rig count and oil price would suggest to us that the focus remains on the US, with a cursory eye on OPEC for any shock announcements. To us, this makes sense, as the US’s estimated reserves are roughly double their proven reserve levels [1] and corporates appear willing to drill wells at an oil price of $40-$50, suggesting that the marginal cost of production for those companies that have survived the fall-out is c.$40.

A low marginal cost of production, significant technological improvement in the E&P space and the relative ease with which fracking wells can be drilled leads us to believe that the oil price will be range-bound between $30 and $60 unless we see a marked pick-up in demand.

 

By James Mee


[1] "Technically Recoverable Shale Oil and Shale Gas Resources: An Assessment of 137 Shale Formations in 41 Countries Outside the United States".Analysis and projections. United States Energy Information Administration. 13 June 2013

 

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