Crude Oil and the Marketshare Standoff

December 1, 2015 11:03 AM

All eyes will be on OPEC this week as leaders from the oil producing cartel assemble to talk production strategy. In the current high supply environment, global producers are in many cases right at the break-even breaking point as global oil prices slog along in a narrow range. That means opportunities to widen margins are few and far between no matter where the operation is located. Take the United States as an example. U.S. Crude production has skyrocketed in recent years, driving supplies to record levels, and prices sharply lower. Rig counts have fallen 60% from the same time last year, and fresh investment money gets harder and harder to pry loose.

Meanwhile, production has continued just above 9 million barrels per day -- an estimated 2.5 million barrels per day above daily demand. If producers are to light a fire under prices, the supply glut will have to be trimmed sharply. Through all of this, OPEC members have been producing at the top end of capacity in order to maintain marketshare. The first producer to reduce production will lose marketshare and may have to close up shop. No producer wants to be in that position. What needs to happen is for all producers globally to come to an agreement and reduce production across the board rather than asking individual producers to take that first step alone.

Since the OPEC meeting last November when producers waived cuts in favor of marketshare, OPEC output has actually increased. Today, a report from Reuters notes November 2015 OPEC production edged slightly higher over the prior month to 31.77 million barrels per day. The November increase was due to increases in Iraqi oil output, but does not yet include supplies from Iran which is expected to dump as much as another 1 million barrels per day onto the global market.

At OPEC's Friday meeting this week, we do not expect Saudi Arabia or any other OPEC member to make significant production cuts. That levers for a catastrophic shortfall in supplies a few years down the road. Once the lack of new projects both at home and abroad hits the oilfields, producers will see prices firm back toward $100 per barrel. That will widen production margins and reinvigorate new projects. Just as we have seen WTI crude take on a cyclical pattern in which short-term rallies bring stalled rigs back online only to have prices fall again amid robust supplies below profitability, forcing some rigs to go back offline.

In the bigger picture, once supplies rebalance and prices firm, there will be a lag before new projects come online. At that point, supplies will once again swell, pressuring global oil prices and discouraging new projects, forcing active rigs offline. It will take about ten years, but if that scenario plays out, and global producers continue to battle in a volume-over-price strategy we will wind up right back where we are today. Burdened by a supply overhang with producers unwilling to be the first to blink in the marketshare standoff.

The short-term benefits to end users and consumers have already been seen in lower fuel costs. That includes propane, heating oil, gasoline, diesel and other finished petroleum products. As long as the marketshare standoff continues, and oil supplies limit the upside in crude prices, end users will keep saving money on fuels. But the lack of new projects and exploration in this low-price environment could easily come back to haunt us once global supplies rebalance in favor of producers.