The decision by members of the Organization of the Petroleum Exporting Countrieson Thursday not to cut production reflects a profound shift in the world oil market. The demand for oil—by China and other emerging economies—is no longer the dominant factor. Instead, the surge in U.S. oil production, bolstered by additional new supply from Canada, is decisive. This surge is on a scale that most oil exporters had not anticipated. The turmoil in prices, with spasmodic plunges over the past few days, will likely continue.
Since 2008—when fear of “peak oil,” after which global output would supposedly decline, was the dominant motif—U.S. oil production has risen 80%, to nine million barrels daily. The U.S. increase alone is greater than the output of every OPEC country except Saudi Arabia.
The world has experienced sudden supply gushers before. In the early 1930s, a flood of oil from East Texas drove prices down to 10 cents a barrel—and desperate gas station owners offered chickens as premiums to bring in customers. In the late 1950s, the rapidly swelling flow of Mideast oil led to price cuts that triggered the formation of OPEC.
And in the first half of the 1980s, a surge in oil from the North Sea, Alaska’s North Slope and Mexico caused prices to plunge to $10 a barrel. That posed a much greater crisis for OPEC than today: Over those same years, global demand fell by more than two million barrels a day owing to a deep recession, greater conservation and the switch to coal from oil for electricity generation. This time world oil demand is still growing, but weakly.
For the past three years, oil prices hovered around $100 a barrel as disruptions in Libya, South Sudan and elsewhere, and sanctions on Iranian exports, eerily balanced out the production increases from the U.S. and Canada. But the slower global economic growth that became apparent a few months ago was accompanied by weaker demand for oil, just when Libya suddenly quadrupled output to almost a million barrels a day. The result: Prices weakened in September and then tumbled.
OPEC’s decision last week reflects the conviction of its “have” nations—the Persian Gulf countries, with very large financial reserves—that cutting output would mean losing market share, particularly to Iran and to what they see as Iran-dominated Iraq. Instead, they have adopted a strategy of leaving it to the market for now; OPEC is waiting, in the words of Saudi Oil Minister Ali al-Naimi, for the oil market “to stabilize itself eventually.”
It is now clear that the new U.S. production is more resilient than anticipated. There has been a widespread view that at around $85 or $90 a barrel extracting “tight” oil from shale would no longer be economical. However, a new IHS analysis based on individual well data finds that 80% of new tight-oil production in 2015 would be economic between $50 and $69 a barrel. And companies will continue to improve technology and drive down costs.
True, with prices now near or below $70 a barrel, U.S. companies are looking hard at their investment plans—where and how much to cut or postpone. But it will take time for these decisions to affect supply. U.S. oil output will continue to rise in 2015.
The OPEC members in big trouble are the “have-nots”—those with small financial reserves and high government budgets. No country clamored more loudly for OPEC production cuts than Venezuela. Once an oil powerhouse, Venezuela depends on oil revenues for up to 65% of government spending. But its production has fallen by a third since 2000. Owing to gross mismanagement, Venezuela’s economy is already in chaos, its political system in crisis and unrest is mounting. And Venezuela would be the No. 1 loser if the Keystone XL pipeline is built, as production from Canadian oil sands would displace Venezuelan heavy oil from its largest single market, the U.S. Gulf Coast refineries.
Iran also clamored loudly for a production cut. High prices earlier this year give Tehran some budget cushion, but the government has little leeway for the next fiscal year. Iran depends on oil for half of its budget, and the country is already suffering from sanctions, which have cut its oil exports almost in half. Lower prices will prolong Iran’s recession.
A few days ago President Vladimir Putin said that Russia, the world’s largest oil producer and not a member of OPEC, is preparing for lower, even “catastrophic” oil prices. Oil provides over 40% of the Russian budget, but Mr. Putin has built up foreign exchange reserves worth a few hundred billion dollars, in part to cope with an oil-price collapse. Still, in an economy that is heavily dependent on imports of food and consumer goods, the falling value of the ruble means rising prices for imports, in effect slashing the incomes of consumers. Combined with the effect of sanctions from the Ukraine crisis, this means Russia is headed for recession.
The biggest impact of lower oil prices on future output may well be not in North America, where many people are looking for it, but in the rest of the world. Even before the collapse in prices, major oil and natural-gas companies had become preoccupied with the continually rising costs of developing new supply and were heeding the call from investors for “capital discipline.”
This price decline will turn this preoccupation into an obsession. The result will be a slowdown and reduction in major new investments around the world. The losers will be the nations trying to woo investment for new oil and natural-gas projects. Countries in Africa, Asia and Latin America are already finding that fewer companies are showing up to bid for new opportunities, and such bids that are proffered will be lower, perhaps much lower, than governments were expecting. The days are past when these countries can insist on very tough terms in taxes, royalties and other requirements that drive up costs and cause delay.
The drama is far from over. If prices remain close to their current level, OPEC members will likely come together again to reassess the market, especially as the stronger winter demand fades with the approach of spring. But a pickup in world economic growth, or new disruptions or geopolitical crises in the Middle East or North Africa or elsewhere, could send prices up again.