Can OPEC Find the Right Balance?

March 2, 2015

There appears to be some belief that supply and demand fundamentals will restore oil prices to the high prices last March. I doubt that cuts in unconventional oil and increases in demand will move oil prices significantly higher in the short-term. Without action by OPEC, prices are unlikely to increase above $55/B over the next several months. We are leaving the highest demand season and E&P budget cuts will take some time before cutting supply. OPEC will be required to cut production to restore prices to the $100/B level.

The real question should not be when will OPEC take action, but what price level should they target. It is doubtful that OPEC will/should aim for $100/B in spite of the wishes of some of their cash-strapped members. At this price level, unconventional oil exploration and development will come roaring back and create the same market condition that led to Saudi Arabia's actions in 2014. OPEC must determine the price which will satisfy the revenue needs of its members and limit the incentives to produce unconventional oil - specifically Canadian oil sands and American shale oil.

A study of 39,000 wells by IHS indicated production growth will stop in the second half of 2015 if the price of West Texas Intermediate crude remains below $60/B.

According to the study:

• About one fourth of new wells in 2014 had break-even West Texas Intermediate prices below $40/B

• Slightly less than half the new wells had break-even prices below $60/B.

• Nearly 30% of new wells had break-even prices above $81/B.

The IHS analysis suggests that non-OPEC production may continue to grow even if prices do not return to century mark.

Therefore, the question is not when oil prices will return to $100/B levels, but whether OPEC can manage markets to maintain their market share. Fasten your seat belts because it is going to be a bumpy ride.

Allen Mesch

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