OPEC, US producers seen in oil showdown

Pricing power at stake in race to the bottom

Suhail Mohamed Faraj al-Mazrouei, the oil minister of the United Arab Emirates, said Tuesday that the Organization of Petroleum Exporting Countries (OPEC) will stand firm on its decision to keep crude output unchanged. His remarks promptly sent oil prices plunging to multi-year lows, with US oil benchmark diving below $45 per barrel.

International oil prices have been falling since the second half of 2014 thanks to concerns over slowing global growth, supply gluts, geopolitical tensions and a strengthening US dollar. Looking ahead, many believe oil prices will remain depressed through 2015.

The main reason behind the current slump can be traced to an imbalance between supply and demand. Wavering levels of economic growth have crimped energy consumption, yet many of the world's largest crude suppliers have failed to adjust their output. Rising production of shale oil in the US over recent years has only aggravated the imbalance. According to al-Mazrouei, the international market is now oversupplied by about 2 million barrels per day.

Despite current market conditions, the US and OPEC have refused to pare down output. OPEC, which accounts for about one-third of the world's oil production, has stated on several occasions that it will keep daily output steady at 30 million barrels a day. OPEC has identified US shale output as the root cause behind falling oil prices, with the organization calling vehemently for the country to reduce its shale operations. For its part, OPEC looks motivated to undermine prices if it will weaken the profits of its emerging shale-oil competitors in the US, who may be less able to withstand a prolonged downturn.

The US accounted for 13.7 percent of the world's oil output in 2013; and local production is currently hovering near a historic high of some 9.1 million barrels per day, 2 million barrels per day more than two years ago, according to media reports. Recent estimates have the US on track to expand daily output by an additional 150,000 barrels per day above current levels in 2015.

Many of the world's major producers are scrambling to increase their own output as part of a strategy to protect market share. Indeed, there are still plenty of profits to be made in the market, since global crude oil demand will rise over the next 25 years, according to American Petroleum Institute estimates. Of course, also in the balance is the economic and political clout that comes with increased international pricing power.

It's not hard to speculate on why OPEC has taken such a firm stance on production levels. It is clear that the cartel wants to push US shale oil producers out of the market and maintain its grip on the world's oil supplies.

It won't be easy for OPEC to pursue its apparent war on prices. The organization will have to keep prices depressed indefinitely if it wants to force shale-gas groups in the US out of business. Played out over the long term, low prices will only create financial strain and social tension in OPEC member nations such as Iran, Venezuela and Nigeria, which have few sources of income aside from crude sales. Here OPEC faces a predicament: should it hold tight to its low-price strategy and risk localized flare-ups which could undermine the group's cohesion?

Yet the group's apparent strategy could well succeed. A weak pricing environment may well destroy the US shale gas industry, sparking a wave of sell-offs, restructurings and bankruptcies over the coming years and months. Analysts at Morgan Stanley estimate that the break-even point for shale oil producers lies somewhere in the $76 to $77 per barrel range, while Citigroup experts see profitability above $70 to $90 per barrel. Whichever figure one uses, it is apparent that current prices will continue to strain US shale oil producers. Signs of stress are already emerging: in December, shale oil producer Continental Resources announced budget cuts, while in early January shale oil miner WBH Energy declared bankruptcy.

The global oil industry's war of attrition may just be getting started. In the end, we may not see a recovery in prices until either the US or OPEC bows to mounting financial pressure.