The U.S. Shale Industry Has A New Sheriff In Town - Dominated OPEC, Russian Meeting Without Being There

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Gary Bourgeault

Summary

Doha only a show meeting, nothing else.

Proposed agreement was a meaningless one that the market quickly punished.

Iran, Iraq, the U.S., Canada and China not being there made it a mystery as to why it was held in the first place.

U.S. shale oil now dominating the decisions made about oil production, and that is to keep on pumping.

It continues to be amusing to see the financial media cover the oil story as if nothing has happened over the last several years that has forever changed the market. That's especially true with the latest meeting of oil powers Saudi Arabia, Russia and Venezuela. Qatar was also there, but it was allowed to show up because it holds the rotating OPEC presidency at this time.

Why I say this is the media still operate under the assumption oil competitors can cut production as they have agreed to in the past and come up with the same results. The last such meeting was in 2001 when Russia agreed to partake in a global deal to lower production. It never complied with the deal, just as many OPEC members have continued to pump oil past agreed to production ceilings in the past.

What's most important in all of this is the misinterpretation of what the impetus behind the need to make the supply cuts in the first place is. It's not a supply cycle, as the media continue to report, but the emergence of the powerful shale industry in the U.S., which make these types of meetings more of a photo op and press release, rather than a legitimate attempt to support the price of oil. In 2001 there wasn't a U.S. shale industry. Today it has propelled the U.S. into being the third-leading oil producer in the world. That has changed everything.

For that reason, every time there is mention of a meeting to support the price of oil, keep in mind the shale industry had no impact on supply in the past, and now that it has, it makes the idea of production cuts an irrelevant relic of the past.

There is also the fact China, which is now the fourth-leading producer, isn't mentioned in the oil conversation, and neither is Canada, which has the third largest oil reserves in the world, behind Venezuela, which has just under 300 billion barrels, and Saudi Arabia, which as a little over 260 billion barrels of proven reserves.

(click to enlarge) source: Bloomberg Click to enlarge

The proposed deal itself

Next let's break apart the proposed deal itself to get a clearer picture of what to look for in the future and how to analyze more meetings, which are sure to come. First, as I've mentioned in past articles, announcements of meetings and engaging in meaningless meetings like at Doha, is an attempt to manipulate the price of oil to the upside. The problem with this meeting is it was so obvious it was a show meeting, it underscored the weakness of the oil market and the inability for competitors to do much if anything about it.

The fact Venezuela has been the major complainer about OPEC's overall production practices because it is an extremely inefficient and high-cost producer, resulted in it bringing Russia to the meeting in hopes of putting some pressure on Saudi Arabia. Russia and Venezuela have a history of working together, and should be considered as closer in their particular outlook on the oil industry and other interests, than Venezuela would be with Saudi Arabia, even though Venezuela a member of OPEC.

As for what can only be considered a silly deal, or proposed deal for other competitors to sign on to, Saudi Arabia and Russia said they now agree to freeze oil production at current levels. All that has to be done is for other producers to agree to do the same. Why it's totally nonsensical is both countries are producing at very high levels, with Russia production now at record post-Soviet levels, which means neither country is really giving up anything by agreeing to the deal. It's a joke. I'm even surprised they allowed the meeting to take place with the media hoopla surrounding it, because it did more harm than good in my opinion. I think Saudi Arabia and Russia probably let it go forward to placate Venezuela and stop it from endlessly complaining about global production levels to the media. The probable reason for that is it kept the supply problems in the forefront of the narrative in certain parts of the world.

About the only interesting thought coming out of the meeting was a comment made by Saudi Oil Minister Ali Al-Naimi, cited by Bloomberg.

"The reason we agreed to a potential freeze of production is simply the beginning of a process" over next few months. "We don't want significant gyrations in prices. We don't want a reduction in supply. We want to meet demand. We want a stable oil price."

There are a couple of ways to take that. The first is it's another attempt to support oil prices by continuing to imply there is an imminent agreement. This is a ploy that's getting old, and I'm sure the market is getting as tired of it as I am. Secondly, it implies a process that is leading up to something else. What could it be if it's not related to a reduction in supply? What else could it be leading up to?

My answer to that is there is hope the increase in demand and expected decline in U.S. shale production will result in the market coming back to them rather than the need to cut supply, which isn't going to happen. That's the reason he covered himself and OPEC by insinuating supply cuts weren't on the agenda; only supply freezes. This of course isn't going to happen because of the return of Iran to the export market. Iran has firmly stated it isn't going to freeze or reduce production. Other OPEC countries such as Iraq have made similar comments.

When including other major producers like China and Canada, which aren't even included in the storyline, it takes all the teeth out of such a proposal. Add to that the fact countries that have higher production costs, such as Canada, are already cutting back on production at some projects, and it further underscores the irrelevancy of this meeting.

When you think it through, absolutely nothing was added to what has been said for many months by those competitors wanting the price of oil to rebound to their benefit.

Power of U.S. shale industry

Many may not think of the U.S. shale industry as a powerful force with oil, but the fact is it has been the catalyst behind the low price of oil and the response of competitors to keep oversupplying the market.

Since there have been numerous bankruptcies associated with weaker and under-capitalized companies, it gives the illusion shale oil can be crushed. That's absolutely not true. Individual companies within the industry can be put out of business, and even large players can be forced to cut or even eliminate their dividends, but you can't remove the shale out of the U.S. It's here to stay.

Add to that the emerging shale industry in other countries, with Argentina probably being the next competitor to enter the market in a meaningful way, and the years ahead suggest the former power players will eventually be forced to give up market share; at least until the point in time global demand rises to the level of supply. That will take a number of years to happen.

The growth of the U.S. shale industry has produced a new problem that has never had to have been dealt with before, which is a producer that can compete at the same level as Saudi Arabia and Russia. In the past, the simple solution to an unbalanced oil market was for OPEC to increase or decrease supply; that option no longer exists because of U.S. shale producers, at least in the sense of it having the impact it has had in the past.

Why that's the case is because of the growth in the amount of oil supplied by shale producers. It's what forced the hands of its competitors to maintain high levels of production in order to protect market share, but more importantly, to buy time to make economic and budgetary adjustments to deal with the new oil market which will be part of the industry for decades.

In the short term, which I mean the next three years or so, U.S. shale producers will remain in the driver's seat as to driving the response of its competitors to market conditions. They are able to do that because they now control the upper and mid-level price points of oil, with OPEC and Russia having more impact on the lower end of the price range. All they can do in response to the shale competition is to keep on pumping or give up market share.

This is one of the reasons I was hoping there would be an agreement made to cut production, as it would prove my thesis to investors concerning the growth of U.S. shale supply now dictating the mid and upper level price ranges of oil. Why that's the case is any attempt to cut supply as in the past would push the price of oil up, which would increase the amount of supply coming from the U.S. shale industry, and other industry players as well, depending on how high the price would rise. How much supply is added would determine the price range of oil after any agreement to reduce supply were put into effect by OPEC and Russia.

Conclusion

There are a lot of reasons to ignore the continual assertions from Russia and OPEC that there is an upcoming supply cut deal that parties will agree to. Not only has the U.S. shale industry changed the oil industry forever and made past responses to an unbalanced market immaterial to today's market, but the past unwillingness to adhere to agreements makes it hard for investors to believe competitors are really lowering production.

Also a factor is another idea being floated around that the big producers have been only asserting they've been producing at very high levels in order to maintain the current levels they're producing at. This all sounds like a plethora of conspiracy theories, but it reveals how unimpressed the market is over these announced meetings and proposed deals, and the lack of trust they would put in them even if they were "officially" agreed to.

An interesting outcome of all of this is if OPEC and Russia continue to imply they are willing to make a deal, eventually they may be forced to make good on the promise, otherwise it could be construed as a nod toward the market being much weaker than perceived, with no real options on the table but to wait for demand to climb over a period of years. I believe, outside of a geopolitical event, that's exactly where the oil market is at today.

Either a deal to cut production will be put in place and OPEC and Russia will be forced to give up market share, or they keep supply at current levels and lose revenue because of the low price of oil. That's the short-term outlook for oil, and I see no other alternatives to the industry.

That's why the U.S. shale industry, by its very existence and growth, is calling the shots now, even if they do nothing but continue to operate. All it has to do is survive this competitive onslaught, which it will. Individual U.S. competitors may lose out, but the industry itself will survive for decades. The U.S. shale industry is now the new sheriff in town.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.