Have U.S. Shale Rebels Taken Over - Or Will The OPEC Empire Strike Back?

| About: The United (USO)
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Summary

Why OPEC move is a sign of weakness, not strength.

Rebel U.S. shale producers are quickly taking control of oil sector.

The OPEC empire no longer has the ability to strike back.

How the new U.S. shale republic will hand its new responsibilities is the question.

source: Stock Photo

Some consider the decision by OPEC and other countries a reflection of the strength and ongoing power of OPEC, but in fact it's nothing less than a confirmation the cartel is in the last days of its waning influence.

OPEC isn't cutting production because it is interested or able to manage the oil market as it has in the past, it has done so because it has failed to crush the U.S. shale industry in a way that would have made it hobble along for a significant period of time, while waiting for global demand for oil to pick up.

The idea OPEC remains the controlling power in oil is a faulty one based upon misunderstanding of the degree U.S. shale producers have disrupted the industry.

This is it for OPEC. It's the last shot it'll be able to take before completely ceding power to U.S. shale producers, which will become the major influencer on the market for years to come. Many don't understand this has already happened, which is why OPEC and Russia made the decision to cut oil production, or least assert they will.

U.S. shale producers went rogue a long time ago, and there is nothing the nationalized OPEC oil companies can do about it.

Misunderstanding the production cut this time around

In the past it was obvious OPEC was the key influence with the price of oil, but this time around, even though the upward movement in the price of oil was anticipated and obvious, it comes with a lot of caveats and differing parameters than in the past.

The most obvious is the large amount of oil being produced by the U.S. shale industry it hasn't had to deal with before. It's not only the amount of U.S. shale oil that is now dictating the market, but the efficiencies and productivity accompanying it.

All OPEC is now doing is trying to get a little more out of oil while it can. This is because U.S. shale producers can now compete at almost any price level because they have taken a lot of costs out of the production process.

For that reason, investors need to learn how to compare apples with apples when analyzing U.S. shale against OPEC. What I mean is OPEC members, to varying degrees, are responsible for taking care of an entire country, or at minimum being a significant part of GDP. U.S. shale companies aren't, so comparing costs of production against OPEC isn't the way to consider the competition, because it's now apparent at where the shale producers are, it's the equivalent of producing oil at about a third of what they are.

In other words, if some OPEC members can produce oil at about $10 per barrel or a little lower, shale producers able to produce at about $30 or so are at about level with them. That's because OPEC must distribute a lot of their earnings to its people to maintain many of the perks supplied in the past. They've been removing or shrinking the perks over the last year or so, but OPEC has to be careful to do so incrementally so it doesn't generate resistance and internal strife, resulting in instigating their own rebellion.

The reason the production cut this time around isn't going to be effective over the long term, is it has never been implemented with a mature U.S. shale industry. OPEC has never had a third competitor (beyond Russia), which is able to step into the vacuum created by a cut and quickly recover at least a portion of it.

The OPEC empire can't strike back

As mentioned earlier, this is being considered as a major aggressive move by many following the oil market, with the idea it's no different than it has been in the past. Not only is this not the case, but when shale oil production surges over the next couple of years, there is little or nothing left in OPEC's arsenal to deal with it. That's why I conclude this is the last big move by OPEC before being understood to be a declining energy power. It's a key reason many OPEC countries are diversifying their economies in preparation for this rapidly approaching reality.

OPEC has been in decline for some time, but the market is finally catching on to just how far along in the process the cartel is.

I know some may look at the percentage of oil represented by OPEC as reinforcing their confirmation bias, but the truth is it's the swing producer that controls oil, and when taken together with U.S. shale companies not having to support a country, it puts U.S. shale in a very strong position.

Think of it. This production cut is different than any other in the past. Not in the details of the cut, but in the reasoning behind it.

To take this as only an attempt to support the price of oil is to not understand the new oil market that has, and continues to emerge.

Not only has OPEC been handily and publicly defeated by U.S. shale producers, it has been done in a way that has pressured it to take drastic measures based on fear, as it not only loses influence in energy, but in the world as well.

U.S. shale as the new sheriff in town

Now that U.S. shale is becoming the key oil competitor, what it does determines the actions of others. That's why they continue to improve efficiencies and increase productivity, forcing those like OPEC and Russia to respond as they have.

How I see it is the reason for the timing of this cut is because there is a short window of time where OPEC can in fact support the price of oil by its actions. This will fairly quickly be challenged by the increase in production coming from shale producers, but also others like Canada and Brazil, which will contribute to a hefty increase in oil supply in 2017.

That window of time was created by OPEC keeping production levels high, which drove down the price of oil, slowing down the U.S. shale industry. The problem which arose was the ingenuity and creativity of shale producers in a short period of time, offset much of the expected results OPEC was looking for. That created internal crises of various member states who struggled to not only maintain a number of subsidies to their people, but in the case of Venezuela, to barely survive.

Conclusion

What is not clear at this time is how U.S. shale producers will handle their new role of market leaders and influencers. It's one thing to be upstart rebels disrupting an existing market, it's another to take up the reins of leadership and guide it in the direction they want it to go.

One clear difference going forward is this. Shale producers, since they aren't nationalized companies, represent a different leadership than OPEC. The idea of attempting to manipulate the price of oil by making production agreements together isn't going to happen. Instead, they'll lead primarily by market conditions, which over time, should represent less volatility than in the past.

When OPEC decided to cut or freeze production over the years, it was an added uncertainty in the market, which wasn't reflective of actual conditions and competition, but artificial intervention. That will come to an end.

What will have to be adjusted to will be the removal of the cartel and the embracing of a market-driven oil market. Some won't like this because they see OPEC as an influencer that makes the oil market more predictable, but I would disagree with that. Now we'll primarily have to watch supply and demand, not the cartel and how it'll respond to it.

That means it won't be decisions based upon the economies of a handful of nations that determines the price of oil in the near future, but the ability of individual companies to compete effectively against one another. It'll transition from national economies being the main driver of oil, to the profitability of numerous competitors.

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.