The Key Question: How Much Longer Will OPEC+ Hold Together?


Jason Bordoff, the Founding Director of the Center on Global Energy Policy at Columbia University, noted on Twitter early Monday morning that "Everyone who’s being writing for years that shale is the new swing supplier, this is what spare capacity looks like. Shale can’t do that. It can grow remarkably (and has) but still takes time to respond and then does so w a lag". His tweet is accompanied by a Bloomberg chart showing Saudi Arabia boosting its overall production by half a million barrels of oil per day during the month of November, a feat only the Saudis are capable of managing thanks to their spare capacity.

Prof. Bordoff is right. While the U.S. Shale industry has shown over the last year that it is capable of increasing production by 2 million barrels per day in 12 months during a time of strong and rising crude prices, it can't just turn on the spigots and pour out another half million barrels per day when it thinks the market can bear such an action. The Saudis can do that - or at least they were able to do it in November, and that turned out to be a problem, given that that action has now been shown to have been a massive overreaction to a market whose fundamentals Saudi Arabia and other oil exporting nations obviously misread.

The other huge difference between Saudi Arabia and the other OPEC+ countries and the U.S. domestic oil and gas industry is that the OPEC+ countries control their crude output levels through policy decisions made by a handful of public officials. The U.S., as a mostly-free market economy, has no such public policy mechanism in place, leaving its crude oil producers free to react to market conditions. The massive increase in U.S. crude production over the past year is the result of thousands of companies competing with one another to obtain the best acreage on which to drill and do everything they can to wring ever-higher levels of ultimate production out of each subsequent well they drill. They've done that extremely well, obviously.

And here's the thing: While Saudi Arabia, Russia and the other OPEC+ nations are promising to enact major production cuts designed to stabilize crude markets at their formal meeting on December 6, the U.S. shale industry is only going to keep getting better at increasing its per-well recoveries and lowering its costs as time goes on. If OPEC+ does follow through on substantial production cuts - Saudi Arabia has publicly stated it may cut its own production by 500,000 bopd - which result in moving the price for West Texas Intermediate back up to the $60/bbl range, it is entirely foreseeable that the U.S. industry will raise its production by another 2 million bopd or even more in the coming 12 months.

When the OPEC+ countries first entered into their export-limitation agreement in December 2016, U.S. daily crude production was about 8.7 million barrels. The U.S. production increase of about 2.8 million bopd over the past two years has basically offset every bit of rising global demand, and the United States, before the huge Saudi November production increase, ranked as the largest crude producting nation on earth, a title it will hold once again should the Kingdom follow through on its promised cuts.

With OPEC now projecting global demand growth for 2019 at 1.36 million bopd, ongoing rapid U.S. production growth will leave the OPEC+ nations once again facing the prospect of having to cut their own production levels in the coming year in order to maintain a strong commodity price. Given the resentment towards U.S. shale that already exists among the OPEC+ community, it remains to be seen how many more rounds of cuts these countries will be willing to sustain before their two-year alliance begins to fall apart.


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