The Force is no longer with OPEC, as the U.S. shale rebellion continues to gather strength and takes further control of the future direction of oil and oil prices, along with natural gas as well.
What OPEC faces is rogue competitors not subject to making deals to artificially prop up and control the price range of oil. Shale producers are ignoring the former catalysts that drove the oil market and are ramping up production after removing a hefty amount of the costs out of the production process.
A number of analysts and pundits continue to operate under the assumption OPEC remains the key player in the oil sector, apparently because it supplies about a third of global demand. The problem is OPEC can't be analyzed in the same way non-governmental companies like the American shale producers, because they to various degrees, are responsible for the nation as a whole, especially Saudi Arabia, which remains overly dependent on oil when compared against most of the other member states that make up the cartel.
What the market has to honestly ask itself is why is OPEC now deciding to attempt to make a production cut when it said in the past it didn't know how to deal with U.S. shale producers, which can quickly ramp up production and increase supply to the market.
The general answer to that is quite simple. It wants to buy time before shale producers roar back to the market after having to slow down production some because of the low price of oil. OPEC is hoping the market will rebalance quicker as a result of a production cut.
There is a race between shale producers returning to the market with abundant supply, and the price of oil moving up in response to growing demand. OPEC's goal is to remove most of the oil stockpile so the market can support a higher oil price on its own, in response to demand growth.
Where the risk lies is if the rogue shale industry once again surprises to the upside and brings more oil to market than anticipated, which would allow shale companies operating in the U.S. to take market share away from OPEC, and possibly Russia, if it agrees to participate in a cut in output.
Beware the media coverage
Mainstream media, and surprisingly, alternative media outlets, still report the proposed OPEC cut as if it has the same importance as it has had in the past. This misguided reporting has made some oil investors complacent in regard to shale producers, as the idea OPEC is starting to flex its muscles and take back control of the market is considered legitimate, even though it no longer has control of it.
Some media are aware of and do acknowledge shale producers can quickly increase production levels, but they imply they don't have the means to do so after OPEC allegedly slowed them down to the point of making them at least temporarily, ineffective.
I agree shale producers have to prove they are able to quickly boost production, but they're already pricking up production pace, and they're doing it at the worst time for OPEC, which may end up reducing production at the time shale producers are kicking into high gear. Add to that the fact U.S. shale producers are now legally allowed to export, and it makes the proposed cut in output much more risky if it is agreed to and implemented.
The reasoning behind the extensive media coverage of the announcement OPEC is going to try to come to a consensus on cutting production, is primarily because it attracts eyeballs. What is concerning as far as the potential impact on some investors is if they don't follow oil much, they can assume, based upon a lot of the coverage, that OPEC still has the ability to control the market. Shockingly to me, I even hear energy analysts and pundits draw the same conclusion.
In the case of the latter, it may be from a conflict of interest or an attempt to cheerlead the price of oil higher and make a quick gain. I have to believe that's the case because it wouldn't make a lot of sense to discount shale producers in any way. Some actually don't understand the disruption of the oil industry. They are likely to take a big hit if they are surprised one way or the other by OPEC and the strength of the resiliency of U.S. shale.
U.S. shale is the future of oil
Some may think because OPEC still accounts for about a third of global oil supply, that they remain in the driver's seat of the industry. It's simply not true. In the past the cartel didn't have to compete against a third major competitor. It only had Russia to deal with when the price of oil dipped or ran up to undesirable price levels.
Now with U.S. shale producers having rapidly becoming a major global force, OPEC can't engage in the same practices to manage the price of oil. This is readily apparent from the fact shale production includes rapid completion of wells, and the ability to quickly start from scratch at a quality location and bring the well into production very fast.
I have no doubt that over the next several years the U.S. will become the leading producer of oil as measured on a country-by-country basis, and even the level it produces at today has brought it to be the swing producer. What shale does is what's important, not what OPEC does.
Some have drawn the conclusion that OPEC's policy of maintaining high levels of production has failed. The truth is it had no choice once it realized the potential the U.S. shale industry represented. It was either allow them to enter the market when the price of oil would help them to grow quickly and profitably, or keep the oil flowing and at least slow it down.
All of this is for the purpose of delaying the inevitable in hopes demand will grow quick enough so the price of oil will climb and everyone wins. That isn't going to happen within the next couple of years, and probably longer, because of the next recession.
For that reason I remain bearish on oil for the short term, but do believe it has a great future in the decades ahead.
The challenge is the emergence of the shale industry has to play itself out in a market that isn't growing demand fast enough to account for the increase in supply. Until that works itself through the system, the price of oil and profitability of high-cost producers is going to remain under extreme pressure.
With low-cost shale producers and the catch-22 of lowering production and opening the door to losing market share, this has put the U.S. shale industry in control of the market, not OPEC.
This is the last hurrah of OPEC, if it does come to some type of production cut agreement. It may have a little period of time, by which I mean probably about six months at best, to support the price of oil. Its gamble is to support oil while waiting for global demand to pick up and offset oversupply.
My six-month figure comes from the fact shale producers are quickly adding supply to the market, and at best OPEC will be willing to hold out until it appears it could be in danger of losing market share. It's not going to let that happen, and neither will Russia if it joins in the agreement.
With thousands of well waiting to be completed, and an unknown amount of oil being added to global supply, OPEC will not wait long to see how its experiment will work under the new market conditions.
Whatever happens, it will be obvious before this is all over that OPEC is no longer the oil empire it once had been, and a new competitor has emerged that is taking over that role; a competitor that is more than determined and able to cut costs and increase supply, allowing it to compete at almost any price point for oil.
All that remains for U.S. shale producers is to work down their higher-cost legacy wells and increase the percentage of their portfolio of premium wells. Once that happens, they'll be able to compete at a level where they'll totally dominate the global market.
OPEC knows this, which is why some are attempting to diversify their economies quicker than they were in the recent past.
With the growth of the U.S. shale industry, the rebellion has now ready to take the reins away from the former global leader. Once demand, led by market forces, does align more with supply, the profitability of shale producers is going to soar. That's why I'm long in my oil holdings.
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.