OPEC agrees to a production decrease, prices increase – but could be just right

Commentary by Marita Noon

At the end of September, the Organization of Petroleum Exporting Countries (OPEC) surprised the markets by agreeing to a production cut. As soon as the 14-nation deal was announced, oil prices jumped more than 5 percent to some of the highest levels since the crash two years ago. (Editor’s note: Locally prices at the pump are relatively unchanged because the area was mildly affected by the Alabama pipeline break earlier in the month, so prices were just beginning to recover.)

The proposed output cap is historic and represents a shift in the “pump-at-will policy,” as Bloomberg called it, “the group adopted in 2014 at the instigation of Saudi Arabia.”

Many analysts see that the Saudi gamble, aimed at putting American producers out of business, has failed. While U.S. oil production is down from last year’s highs and bankruptcies are up, the industry has become more efficient and the cost of extracting oil from shale is continuing to come down – resulting in the sixth straight week of an increased rig count and the 15th without a decrease. Wall Street Journal (WSJ) reports: “Many oil producers believe drilling in some U.S. regions can be profitable even with oil prices in their current range of $40 to $50 a barrel.”

Additionally, U.S. crude stockpiles have fallen for the fifth consecutive week – as have crude imports. American drivers are consuming more gasoline than ever. Exploration budgets, due to the low oil prices, have been slashed with the predicted result of lower production in the next few years. It appears that demand is catching up with production and prices have been creeping up since February’s lows. Phil Flynn, senior market analyst with the PRICE Futures Group explains: “While supply is still at a historically high level for this time of year, strong U.S. demand and rising U.S. exports are cutting down the glut.”

Meanwhile, the social costs of low-priced oil have been high for OPEC members – hitting Saudi Arabia especially hard. The cartel’s biggest producer has lost billions of dollars of revenue, which has resulted in a 20 percent pay cut for its ministers, reductions in financial benefits for government employees, and an increase in fees and fines, and cuts in subsidies, for all in the kingdom. Fear that the loss of the coddled lifestyle could throw the country into chaos, according to industry veteran and consultant Allen Brooks, likely convinced Saudi Arabian officials to moderate their position. The view from Bloomberg concurs: “Saudi Arabia’s willingness to do a deal, in particular, demonstrates the economic pain lower oil prices has caused producers.”

Iran, OPECs other majordomo, has, due to sanctions, gotten used to austerity and is now seeing its economic pressures easing and its oil exports increasing. It, therefore, heading into the OPEC meeting, appeared to be rejecting the Saudi output offer and dashed hopes of a compromise to cut crude production. The Financial Times quotes one Gulf OPEC delegate as saying: “All producers are hurting.”

The surprise came on Wednesday, September 28, when, after two years of failed attempts at an agreement and months of dialogue leading up to the meeting, “Saudi Arabia agreed to take on the bulk of OPEC’s proposed cuts,” wrote the WSJ. The headline from the New York Times read: “OPEC agrees to cut production, sending oil prices soaring.”

The proposed cuts are moderate in reality, only 1-2 percent of the 14-nation cartel’s 33.2 million barrels a day of production and they represent less than 1 percent of total global production. Yet, the announcement buoyed markets and added power to the previously mentioned price momentum. According to CNN Money, the agreement offers “powerful symbolism.”

While the price of oil received a bounce from the news that has given the industry cautious optimism, it is not expected to have a big impact on the price of gasoline. Oil prices are now expected to stay near $50 a barrel through the end of the year and below $60 a barrel through 2017 – which will likely mean an increase of a few cents a gallon at the pump. Julian Jessop, chief global economist at Capital Economic, in CNN Money, called the situation “a period of ‘Goldilocks’ oil prices” – low enough to help consumer spending and “high enough to keep major producers afloat.”

The slight bump in prices the proposed deal adds to the upward trend is enough to send some producers back into the oil field and encourage another burst of drilling. That increased production will have a self-leveling effect on prices. As prices go up, production increases. As more oil enters the already-glutted market, prices come down.

Additionally, the OPEC agreement is only a plan. It isn’t finalized. That could happen in Vienna in November if, and it is a big if, the members can agree on who will make the cuts, when the cuts will go into effect, how long they will last, and how they will be enforced. While all 14 countries – and non-OPEC producers such as the U.S. and Russia – will benefit from higher prices, no one wants to be the one taking the cut. Iran, Libya, and Nigeria are all trying to increase production that has been stifled due to sanctions or conflict. Plus, as WSJ reports: “OPEC has a long history of agreeing to production cuts, only to have the pact collapse when countries change their minds.” CNN Money adds: “cartel members also have a tendency to overshoot production quotas.”

So, while the OPEC announcement is “not a game-changing move that will send oil prices shooting back up towards the $100 a barrel level,” as The Guardian reported, it is big news that brightens prospects for the energy industry while keeping things just right for consumers.

The author of Energy Freedom, Marita Noon serves as the executive director for Energy Makes America Great Inc., and the companion educational organization, the Citizens’ Alliance for Responsible Energy (CARE). She hosts a weekly radio program: America’s Voice for Energy – which expands on the content of her weekly column. Follow her @EnergyRabbit.

The start of something good?

Last week, Mark Green at the Energy Tomorrow blog posted a critique of the proposed fracking regulations Maryland may adopt in the waning days of the O’Malley administration. In his piece, Green stressed that Maryland needed to adopt “sensible” restrictions but feared Maryland would go too far. It was echoed in the Washington Post story by John Wagner that Green cites.

But the money quote to me comes out of the Post:

“In the short term, as a practical matter, the industry will probably choose to frack in other states than Maryland where the standards are lower,” O’Malley said. But in the longer term, he said, “it could well be that responsible operations may well choose to come here.”

Or maybe not, which seems to have been the goal of O’Malley and Radical Green all along. It’s funny that they don’t seem to have the objections to wind turbines dotting the landscape despite their own health issues. Certainly no one studied them to death.

Being a representative of the energy industry, Green naturally argues that “sensible” regulations are similar to those already in place in states which already permit the practice. As he notes:

Hydraulic fracturing guidelines developed by industry – many of them incorporated into other states’ regulatory regimes – offer a sound approach proved by actual operations.

I can already hear the howling from Radical Green about the fox guarding the hen house, and so forth. But is it truly in the interest of industry to foul its own nest?

On the other hand, the success of fracking and other domestic exploration may create an interesting situation. Even back in October, when oil had declined to $90 a barrel from a June peak of nearly $115 a barrel, analysts were speculating on the effects the drop would have on the budgets of OPEC member nations. Now that oil in closing in on $60 a barrel, the economic effects on certain nations will be even more profound, and contrarian economic observers are already warning that the oil boom is rapidly turning into a bust with a ripple effect on our economy.

Even the revenue scheme by which Maryland would collect a sales tax on gasoline depended on gas prices staying somewhere over $3 a gallon. Assuming the price of gasoline stays at about $2.70 per gallon through the first of the year, the predicted 8-cent per-gallon rate will only be 5.4 cents. (The sales tax on gasoline is slated to increase to 2% on January 1.)

In any case, there is a price point at which non-traditional oil extraction such as fracking or extraction from tar sands – the impetus for the long-stalled Keystone XL pipeline – becomes economically non-viable. I had always heard that number was $75 per barrel, which was a number we had consistently hovered above for the last half-decade. Now that we are under that number, the question of exploration in Maryland may be moot for the short-term, although the price of natural gas is only slightly below where it was this time last year so that play is still feasible.

Whether the decline in oil prices is real or a manipulation of the market by a Saudi-led OPEC which is playing chicken with prices to try and restore its bargaining position by outlasting domestic producers, it may be yet another missed opportunity for Maryland as it could have cashed in during a difficult recession and recovery if not for an administration which believed the scare tactics and not what they saw with their own eyes as neighboring Pennsylvania thrived.