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| If OPEC members relied solely on energy revenues. |
Here is a little background to the international political economy of the ongoing OPEC meeting. As you would expect for a multi-billion dollar industry, the stakes are very, very high. What's more, with oil prices sliding as a result of slowing growth in the world economy, the showdown is becoming an n=2 fight. For OPEC, Saudi Arabia represents the "swing" producer as the largest entity and therefore the one with the most sway within the cartel. The bogeyman, of course, is the United States which has become the world's largest energy producer on the back of the shale / hydraulic fracturing revolution that has made previously inaccessible energy supplies accessible...at a price.
The upshot of it all is that it's a highest-stakes game of chicken between Saudi Arabia--not really "OPEC"--and the US shale producers. The Saudi's
gambit is to not restrict OPEC production in the expectation that, at current price levels, many shale operators will become uneconomic--especially if prices remain as they are now for a protracted period:
Then there’s Saudi Arabia, which is still at the wheel of OPEC as its top producer. The Saudis still enjoy some of the lowest production costs in the world, so they can sustain a much lower price and still not worry about financing themselves. That’s a luxury many OPEC members don’t have. Venezuela, Iran, Iraq, Libya, and even Russia all need oil prices higher than $100 a barrel to keep their deficits in check.
Right now the Saudis are a lot less worried about the budget deficits of their fellow oil exporters as they are about what’s happening in North Dakota and Texas. The biggest threat to the power the Saudis have wielded as the de-facto head of OPEC for the past 30 years isn’t cheap oil; it’s the 9 million barrels a day coming out of the U.S. The Saudis would much rather play a game of chicken with U.S. producers than bow to the wishes of Iran, which they’re in no hurry to accommodate given their disagreements over the Assad regime in Syria, not to mention Iran’s burgeoning alliance with Iraq.
For decades Saudi Arabia has been the preferred partner of the U.S. in the Middle East. At the heart of that partnership was America’s clear dependence on Saudi Arabia for its oil. But that dependence has diminished significantly over the past few years as U.S. refiners have substituted oil from the shale boom for imported oil.
As with the earlier blog
post, the thing Saudi Arabia must do is keep OPEC members with higher breakeven costs in line as they keep haranguing Saudi Arabia for reduced output. Ironically, attempting to squeeze shale producers is more likely to put the squeeze on fellow OPEC members with higher production costs than the Americans using new technologies.
That said, nations with few other sources of revenue will likely persist for much longer than
highly leveraged shale producers--or at least that's the reading of Saudi Arabia:
At $100 a barrel, the average oil company can generate net income on the order of $15 a barrel. But as prices fall, this margin evaporates quickly. A decline of $10 to $90 leaves a margin of only $5, that means profits plunge 66%. Thus, at current prices, the average oil company won’t be profitable at all, and the weaker ones, loaded up with debt, are the walking dead. A perfect example is Goodrich Petroleum GDP -6.41%, which announced some big new discoveries in the Tuscaloosa Marine Shale. While the oil may be there, “the play is not economic at current oil prices,” wrote Cowen & Co. analyst Christopher Walling yesterday, adding that “liquidity is a growing concern.” Goodrich shares are down 70% in six months...
So who’s in the worst shape? The companies with a combination of high debt, high costs and relatively poor acreage, like Goodrich. Another early casualty could be Swift Energy, which has piled up $1.2 billion in debt in recent years to drill high-cost wells on marginal acreage. Swift’s investors are clamoring for change as shares have plunged 50% this year. Swift’s net debt has climbed to more than 3 times estimated 2014 EBITDA, or more than 80% of enterprise value.
According to data from U.S. Capital Advisors, other operators with high leverage that are living well outside their means include SandRidge, which has debt of 2.6 times EBITDA and 51% of enterprise value; EXCO Resources XCO -7.95% with debt 4.3 times EBITDA and 83% of enterprise value; and Magnum Hunter Resources MHR -4.38%, with debt 4.8 times EBITDA and 38% of enterprise value.
UPDATE 1:
Reuters has
estimates from various financial researchers on breakeven prices for American shale producers. As you can see, we are well below the weighted average breakeven point already with WTI crude's spot price now
under $70. So, it's game on for Saudi Arabia and the US-based prospectors they wish to drive out of business:
ROBERT W. BAIRD EQUITY RESEARCH (Oct. 14)
"We estimate $73 as the weighted average breakeven point for
U.S. supply."
SHALE FIELD BREAKEVEN OIL
PRICE PER BARREL
Eagle Ford Liquids Rich $53
Wolfcamp North Midland $57
Bakken Core $61
Niobrara Extension $64
Eagle Ford Oil $65
Niobrara Core $68
Wolfcamp South Midland $75
Bakken Non Core $75
Texas Panhandle $81
Mississippi Lime $84
Barnett Combo $93
Bottom line - don't be surprised to see marginal shale producers driven out of business. Namely, those which are highly leveraged and have smaller plots whose reserves are harder to extract.
UPDATE 2: Tim Mullaney of
MarketWatch argues that while there are marginal US shale producers, the production costs of larger firms are rather low, making Saudi Arabia's gambit a dubious one.
