Oil Price Wars 2021

I wrote previously about the importance of the rise of shale oil in the US and the impending net energy independence of the US. Let's dive under the surface on this to see how things are going.

US Oil Production

As I write, the price of oil is back under $60/bbl, a very important level for the industry. At $60 effectively all US production is profitable.

In a recent article on OilPrice.com, Tsvetana Paraskova wrote:

Across all U.S. oil-producing regions, average breakeven prices to profitably drill a new well range from $46 to $58 per barrel, with breakeven prices in the Permian averaging $50 a barrel, the latest Dallas Fed energy survey for Q1 showed last week.

You can not flip a switch and bring more oil to market. It takes roughly 9 months for higher prices to translate into higher shale production. Also, some large US producers remain hesitant, even at $60/bbl to break ground on new wells because of the uncertainty over future prices. This has left a window for smaller operations to grab some much needed profit. Creating a more diverse industry in the US top to bottom. The more the oil price ventures over $60, the more production the large companies will bring on.

Right now there is excess US capacity. The most oil produced per day in the US was 13 million barrels in February 2020. During 2020 that crashed 25% to 9.7 million bbl/d, but has rebounded to currently 11.1 million bbl/d as of the last week of March 2021.

The latest EIA estimates are for US production to be back above 12 million bbl/d by next year, and I suspect it will be higher, possibly pushing 13 million again due to macroeconomic factors.

Next year, however, U.S. production could average as much as 12 million bpd. That’s the latest EIA forecast from the March Short-Term Energy Outlook (STEO). The EIA raised its 2022 production outlook by 500,000 bpd compared to the estimate from February because of higher expected oil prices.

OPEC

OPEC is going out on a limb apparently and betting that global oil demand will pick up this year due to the post-virus recovery (that we haven't seen yet). They expect demand to increase and so are slowly increasing their production by 1 million bbl/d. OPEC is trying to keep prices around $60/bbl where the large American producers have shown makes them hesitant. If price were to spike, OPEC would be facing more competition. It's a balancing act.

OPEC thinks they can bring a bit more supply on the market to meet the new recovery demand, all while keeping price around $60/bbl. It's a dangerous game, because the global economy is not about to recover. Likely what this will lead to is lower oil prices as production increases by roughly 2 million bbl/d globally by the end of this year.

The Saudis are so threatened by US oil producers, they are starting to offer oil for different prices to different customers. Their Asian customers will get charged more, while oil sold to US customers will be for slightly cheaper. It is a tactic specifically designed to suppress US oil production.

Gasoline price

Average US gasoline prices are at 5 year highs. That is however, after 25% of US production was taken offline in 2020. The supply shock was immense and it only managed to boost prices to the top of 6 year range.

As shale production ramps up again and the oil price gently falls, gasoline prices should also gently fall. Marginally more shale will make it to market, OPEC will pump more, and Saudi is going to sell it cheap to the US.

Inflation

This puts downward pressure on all other prices in the US economy since gasoline is a large component of all prices. The CPI is very closely related to the price of gasoline, almost to a fault.

There is very little hope for the Fed's attempts to stimulate growth and inflation. US unemployment is still ridiculously high and the global post-virus recovery is going to get squashed by many countries aging demographics. They simply won't be able to achieve pre-virus productivity rates as their populations age quickly.

Lastly, China is the wild card. I watch events related to the Chinese economy and trade relations very closely. China is quickly becoming a global pariah. Their treatment of Hong Kong, their own people, and specifically the Uyghurs, has galvanized international sentiment against them. Condemnations of China are about the only unanimous decisions out of the Western countries at the moment. Despite the rise of populism, the one thing everyone seems to agree on is a strong stance against China.

If the Chinese and central Asian demand for oil slips the way I think it will, the oil price could be slashed again. If the West stands firm, China's export driven economy slows way down, and the ability for President Xi to retain control becomes strained. The likelihood of a Chinese collapse is a risk that OPEC and the world is massively underpricing.