Macro Commentary
Last week we talked about how market prognosticators were split on their guess on what action, if any, they would take. The results are in and the decision makes OPEC appear that they are stepping back from their long running role of controlling prices. In a statement, the Secretary-General of OPEC stated that the group is “not sending any signals to anybody, we just try to have a fair price.” Too bad the market sees every decision as a signal. Both US and international oil spot benchmarks fell by $5 each (north of 6%) on the news as the market tests their resolve. According to research from many sources, at least nine of the twelve members of OPEC need higher oil prices to balance their budgets. Instead, they seek to crowd out producers with higher marginal costs. Pundits again point towards the onshore US shale plays who have added about 1mm barrels per day of production in each of the past three years and is expected to continue that trend for a while longer. According to work done by the International Energy Agency (IEA), only 4% of the US shale production needs $80 or more to be profitable. The financial markets are going to be quick to sell first and ask questions later, however, as they do not have a clear historical gauge to say where the price thresholds are that slow or stop production. And even then, those thresholds change as innovation and experience lower the costs of production for entrepreneurial producers. What is most at risk are the big offshore projects that involve deep water drilling or more other intense extraction processes like the oil sands. That might put more squeeze on projects out of Africa, South America, Mexico, and Antarctica and the major integrated oil companies who invest there. Who will blink first? Big integrated companies looking at multi-billion dollar projects with cash returns years out, mid-sized US shale producers who have had the gas pedal all the way down, or Middle Eastern conventional producers with governments to finance?