OPEC and Russia’s Vulnerability, and America’s Ingenuity

Through iteration, experience, and innovation, North America is producing oil cheaper. According to IHS, the median North American shale needs a crude price of $57 per barrel to break even today. Last summer, North America needed a breakeven price of $70. While lifting costs have fallen in North America, there are high levels of anxiety among OPEC producers and Russia as a result of the recent drop in oil prices.

America’s inventiveness

Morgan Stanley claims that producers are getting more oil per dollar spent drilling, driving down costs by as much as $30 per barrel since 2012. What are the key drivers that have led to lower costs? Houston-based PacWest Consulting Partners estimates that companies are fracking horizontal wells in more stages, rising from an average of 18 in 2012 to 23 by next year. More wells are being drilled on each well pad, with as many as 16 wells from a single pad.

Drilling costs are also dropping. EOG Resources, an early participant in many shale plays, has significantly reduced its drilling costs. In the Permian Basin, EOG has reduced drilling costs from $6.9 million in 2011 to $5 million today. As a result, cash margins have improved significantly. As more than 18,000 horizontal wells are set to be drilled in the U.S. in 2014, it will be interesting to see if drilling costs continue to fall, and to what extent.

Source: EOG Investor Presentation (October 8, 2014)

America’s wells are not only cheaper, they are producing more hydrocarbons. According to EIA data and analysis by Mark Mills, a senior fellow at the Manhattan Institute, the quantity of shale or natural gas produced per rig has increased by more than 300% over the past four years.

OPEC and Russia’s dilemma

Last month, Reuters surveyed nine consultancies, banks, and independent analysts to determine the minimum oil price OPEC members require in order to meet government expenditures. The survey concluded that countries such as Iran and Nigeria required the highest oil prices to cover their expenditures, while Kuwait and Qatar will be able to cover their obligations with today’s lower prices.

Source: Reuters

The survey also identified the marginal cost of producing one new barrel of oil in specific regions of the world.

Marginal cost of producing one new barrel of oil

Source: Reuters

Venezuela has already restructured — some have used the word defaulted — on its $500 billion loan program that until recently required 300,000 barrels per day to pay China back. Saudi Arabia announced it would maintain production levels to keep market share. Some, including Ed Morse of Citi and Amy Myers Jaffe of the University of California at Davis, believe that OPEC’s demise could be imminent. Morse told The New York Times this month: “OPEC is not going to survive another 50 years. It probably won’t even survive another 10.”

What does OPEC’s vulnerability and America’s ingenuity mean for international benchmark oil pricing going forward? Morgan Downey, CEO of Money.net and author of Oil 101, recently told CNBC that oil prices could fall to $70. If OPEC producers continue to fail at cutting production and U.S. oil production hums along, expect prices to stay relatively low. If this does happen, expect the U.S. to become a new swing supplier.

Originally written for OilPrice.com, a website that focuses on news and analysis on the topics of alternative energy, geopolitics, and oil and gas. OilPrice.com is written for an educated audience that includes investors, fund managers, resource bankers, traders, and energy market professionals around the world.