OPEC is likely to extend its production cuts at the group's biannual meeting Thursday, but questions remain on the duration, size and scope of the reduction, as giants like Exxon Mobil (XOM) and Chevron (CVX) join shale producers in the rush to pump more oil — and potentially send U.S. output to record highs later this year.
In November, OPEC and top non-OPEC producers like Russia agreed to remove 1.8 million barrels of daily output off the market for six months starting in January. Prices rallied but then came back down as U.S. producers ramped up faster than expected and as inventories shrank slower than expected. By March, OPEC had started talking about extending the agreement by six months to the end of the year.
OPEC's de facto leader, Saudi Arabia, along with Iraq, Iran, Kuwait, the United Arab Emirates, Algeria and Venezuela, who collectively represent more than 80% of OPEC's output, have already said publicly that they support extending the cuts in some form.
But Russia and Saudi Arabia have suggested taking the deal even further, saying they support extending the deal to March 2018.
"There has been a marked reduction to the inventories, but we're not where we want to be in reaching the five-year average," Saudi Energy Minister Khalid al-Falih said at a briefing in Beijing with Russia's Alexander Novak on May 15.
On Saturday, al-Falih told Bloomberg that "everybody" he has talked to backs a nine-month extension. But on Monday, al-Falih reportedly visited his Iraqi counterpart in Baghdad to convince him to back a nine-month deal instead of a six-month one. Last year, Iraq had pushed to be exempt from the initial cut, saying it needed money to fight the Islamic State. It agreed to participate in the cuts but is considered a major cheater.
The International Energy Agency warned last week that merely extending the deal won't be enough to bring markets in balance. Instead, deeper cuts are needed.
And analysts at Citigroup have said there is a 60%-70% chance OPEC and its allies will announce an even deeper cut, taking 300,000-500,000 more barrels per day off the market.
"An extension is in the bag," said Phil Flynn, senior market analyst at Price Futures Group. "I would be shocked if it wasn't extended, and I wouldn't be surprised if OPEC announced an even bigger cut going forward."
On top of that, the scope of the output reductions could be broader, as Russia and Saudi Arabia are also pushing for non-OPEC members Turkmenistan and Egypt to participate in the next round. OPEC members Libya and Nigeria, which were exempt from reductions under the initial round, may participate in the next, while Iran, which was also shielded from cuts, has signaled it will maintain a cap on its output.
In a note Monday, Goldman Sachs said a nine-month deal would help "normalize OECD inventories" by the start of next year. But the analysts warned that once the deal was over, stockpiles would start rising again.
Goldman said that OEPC and its allies should "gradually ramp up production to grow market share but keep stocks stable and backwardation in place," referring to the situation when a commodities' future contract price is below the current spot price.
"Low forward prices could curtail shale's growth by reducing the ability to secure future cash flows and attract funding," Goldman said.
The Price That Producers Need To Break Even
Talk of more-aggressive moves has helped lift crude prices, with U.S. oil topping $50 a barrel again after rising 5% in the past week. Brent is now at a one-month high, above $53 a barrel.
But OPEC members whose governments rely heavily on oil revenue need a higher price than that to stay out of red ink. Saudi Arabia's "fiscal break-even" price is $83.80 a barrel, according to an IMF report last month. Oman's is $79.20, Libya's is $71.30, and the United Arab Emirates' is $67. Others are in better shape, with Iraq's at $54.30, Iran's at $51.30 and Kuwait's at $49.10
Meanwhile, U.S. producers learned during the oil crash how to become leaner and operate within cash flow at lower oil prices. They don't need to support government coffers either and are poised to boost production further if OPEC manages to raise crude prices again.
Companies in the Permian Basin have break-even prices of $34 in some areas, according to Bloomberg Intelligence. Earlier this month, EOG Resources (EOG) said it could hit its target of an 18% increase in oil production, while operating in its cash flow, if oil averages $47 per barrel this year.
And Pioneer Natural Resources (PXD) said recently that its break-even oil price is just $20 a barrel, and the company could make "good returns" at $40 oil. Plus, deep-pocketed heavyweights like Chevron, Exxon Mobil and Royal Dutch Shell (RDSA) plan to focus more spending this year on U.S. shale plays.
That leaves OPEC with another dilemma, but one it is unlikely to resolve next week, if ever.
"There is of yet no long-term strategy for dealing with shale oil, so any rebalancing will be temporary," Omar Al-Ubaydli, an affiliated senior research fellow at George Mason University, said.
U.S. production fell in the prior week for the first time since February, according to the Energy Information Administration. But output is on pace to top the April 2015 peak of 9.61 million barrels per day by July, and Flynn has said it could even reach 10 million barrels per day by August.
Still, Flynn is more bullish on OPEC's future, noting that it takes time to boost production from unconventional wells due to their steep rate of decline, whereas traditional wells like those in Saudi Arabia can produce at a high rate for several years.
"Even now with shale's resurgence, as demand grows in the coming years (OPEC) feels that because of the lack of investment in more traditional projects by oil companies, they will have a leg up in being able to ramp up production to meet demand in the future," he said.
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