US shale boom putting OPEC on the defense

OPEC’s weakening grip on international oil markets is causing a lot of head scratching and hand wringing among countries that aren’t used to not getting their way.

While the Organization of the Petroleum Exporting Countries is studying the U.S. shale boom’s impact on the cartel, analysts say there is very little OPEC can do — and, some argue, should do — to turn the tide.

“I imagine some members of OPEC may be flipping out over shale oil,” Morningstar analyst Jason Stevens said.

That doesn’t mean U.S. consumers should expect the changing dynamic to cause a sharp drop in prices for crude and gasoline over the long-term.

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At least for the time being, OPEC appears to be taking a measured approach, even as some of its 12 member countries pressure the group to be more aggressive in tightening production to prop up prices in support of government budgets that rely heavily on oil prices of $100 a barrel or higher.

OPEC oil ministers opted last month at their most recent meeting to keep production steady at 30 million barrels a day. They said the relative steadiness of prices so far this year shows the market is adequately supplied.

Brent crude, which is used to price oil from the North Sea and is the benchmark for world prices, traded around $100 a barrel last week while West Texas Intermediate, the U.S. benchmark, was about $94 a barrel. The spread has narrowed significantly in recent months.

U.S. gasoline, meanwhile, averaged $3.65 a gallon for regular last week, up 3 cents over the same week in June of 2012, according to the U.S. Energy Information Administration. It averaged $3.370 a gallon in Texas Friday, according to AAA.

Refined product prices are tied more to Brent crude than to West Texas Intermediate. So while higher U.S. oil production reduces imports, it may have little impact on prices at the pump, unless it leads to lower worldwide oil prices, analysts say.


Market shocks or other factors could cause OPEC to change course in the future, and oil ministers are keeping a close eye on growth in U.S. oil production from shale plays in Texas, North Dakota and elsewhere that are bursting with activity, thanks to advances in hydraulic fracturing technology and horizontal drilling.

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According to an Energy Information Administration report last week, U.S. reliance on foreign oil continues to decline.

The report noted that in 2010, the U.S. imported to the Gulf Coast 886,000 barrels per day of light sweet crude (the grade of both Brent and West Texas Intermediate.) By March of this year, imports had fallen to less than 40,000 barrels per day. Also, U.S. crude oil exports to Canada have increased from a historical average of 24,000 barrels per day to 100,000 barrels per day over the first quarter of this year, the Energy Information Administration said.

OPEC said at the close of its May 31 meeting that “member countries would, if required, take steps to ensure market balance and reasonable price levels for producers and consumers.”

One way to boost prices is to cut production, on the theory that if demand remains steady, lower supply will lead to a corresponding hike in prices.

Oppenheimer & Co. analyst Fadel Gheit said OPEC has reason to worry about the U.S. shale boom. But he argues higher oil prices aren’t the antidote.

“OPEC has become accustomed to high oil prices, but unless they change the way they spend their export revenue, they could be ready for a rude awakening,” he said.

Gheit said OPEC “needs more efficient, equitable and transparent ways of sharing its wealth, mainly by eliminating corruption and waste.”

He noted that “high oil prices are accelerating investments outside OPEC, especially North America, Australia, offshore Africa and Brazil, and technology is boosting production.”

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Those trends are affecting exploration and production companies, services companies that work in the oil and gas industry, and consumers.

The relatively low price of natural gas also is a factor in the oil landscape, Gheit said.

“We are likely to see more gas replacing oil in transportation, in addition to renewable energy,” Gheit said. “Oil service companies will have to provide more technology to help oil companies reduce cost and improve capital efficiency.”

So, have the weakened OPEC influence and increased U.S. oil production beckoned a new world order? Not so fast, said Stevens, the Morningstar analyst.

“It’s really the same old boom-bust cycle we’ve seen every time a major new oil producing province comes online,” Stevens said. “Much will depend on how each nation and company responds to price signals.”

Stevens said that in the future some OPEC nations could argue for reduced production in order to support prices, but in the end it all comes down to Saudi Arabia, the only nation with material spare production capacity.

“Saudi Arabia plays a long game — they’re less worried about oil price volatility than other OPEC nations, and less likely to make knee-jerk decisions,” he said.

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And Stevens said that while U.S. shale production is growing, no one can say for sure how much it will really grow and how sustainable that growth will be. He said an argument could be made that production growth will peak in the next few years if the industry doesn’t find another oil-rich play or slows down spending on drilling.

Another argument for OPEC to be cautious about any aggressive moves to curtail production: Excluding OPEC and the U.S., world oil production is in decline. Stevens says that means that even with U.S. growth, the market is likely to remain fairly tight barring a major demand shock.

The trickle-down effect on the industry is where there could be some real movement.

Stevens said he believes one of the more likely outcomes of the greater price uncertainty will be increased industry consolidation. Lower prices could bring significantly more attractive valuations for many companies and assets, prompting companies with lots of cash but limited growth opportunities to buy production growth, he said.

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