When oil prices began falling last summer, analysts were slicing and dicing the wherefores and whys that, minus a major catalyst similar to that of 2007, why did prices start a free-fall? “Perfect Storm” many theorized, alluding to the strong dollar, declining demand due to economic stagnation in Europe combined with ‘only’ 7.5% growth in China, Vladimir Putin and his antics in Crimea and the Ukraine, and rapidly growing production from the United States due to the new-found national F-bomb: Fracking.
In mid-October, Saudi Arabia clearly set its sights on America’s shale revolution, by specifically targeting a price increase of Middle Eastern oil bound for the U.S., while raising the price of the same crude destined for Europe and Asia. That sent shock waves through the markets, and oil valued over $100 a barrel quickly found itself only worth $90, then $80, then $70. Without any further catastrophic catalyst, that same oil is now trading near $45 per barrel. World demand last summer isn’t down drastically enough by any means to warrant a 60-percent drop in price. And production isn’t up substantially more than it was when oil was at $107 to warrant the price falling off a cliff.
There was one clear and obvious external factor that led to the precipitous drop: A Saudi-led vendetta against the United States. Whether the catalyst was market share, flexing their weakening muscles, or a disdain of recent U.S.-Saudi relations is anyone’s interpretation, but clearly Saudi is out to slow things down in the American oil patch. Furthermore, they were so willing to do this that they jeopardized the very fabric of OPEC, virtually alienating those countries less capitalized, like Venezuela.
However, there’s another perfect storm that may be in the making. OPEC’s Secretary General, Abdalla El-Badri was quoted this week saying he thinks oil could snap back to $200 a barrel due to a lack of investment in new production. Analyst estimates of lower production and less spending on new development grace the headlines virtually every day. Yet, output from U.S. shale has continued to climb, peaking thus far at 9.192 million barrels per day the week of January 9, 2015.
Another component of this perfect storm is the decline curve of shale wells. Known to produce high volumes of oil initially, shale wells decline within the first three years to a level of production they generally maintain for up to several decades. But the fireworks happen in the first three years. That means every shale well across the U.S. is somewhere on that declining curve right now. With less production coming on line, eventually the steepness of the decline will surpass the much slower new-growth, and we will see declining domestic production.
Trend reversals in the oil field take time. By summer 2015, when production declines are fully in effect, it will have been nearly a year since prices first cracked. Most likely, investment in new rigs will be slower to return, so you could rather easily project this as a 2-3 year trend of lower supply in the United States.
Now for the rest of the perfect storm. Despite the current international recession combined with the positive affects of improved conservation measures, world oil demand estimates project 119 million barrels consumed per day by 2040 according to the Energy Information Administration. Bottom line: Macro demand is still trending up.
According to the 2011 production quota agreement, OPEC is producing 30 million barrels of oil per day, and that has been reallocated to other parts of the world as U.S. production increased. As investment in new oil development slows down, so will U.S. output. If OPEC, primarily led by Saudi Arabia, refuses to either re-allocate shipments of current production, or refuses to increase production to meet declining U.S. inventories, America could find herself in another crisis like we were in 1973.
One other component of the storm could be the icy relations between Washington and Riyadh. Because of several rebuffs by the Administration to Saudi requests for allied assistance (dating back to the Arab Spring), Saudi Arabia seems much more inclined to ignore American energy interests over their own.
In 1973 and 1974, Americans lined up to buy gas. Rationing prevailed as the nearly seven-month embargo cut supplies by 25-percent to all Israeli allies during the brief Yom Kippur war. Oil prices more than quadrupled to a whopping $12 per barrel. The Nixon Administration imposed price restrictions that would last into the Reagan Administration. In 1975, President Ford signed the Energy Policy and Conservation Act, creating the Strategic Petroleum Reserve, further regulating oil prices and imposing the ban on all crude exports from U.S. mainland ports except to Canada.
Could we be shaping up for another oil shortage, when just a few months ago the problem was just the opposite? Time will tell. When the Secretary General of OPEC, the man charged with carrying out the Minister’s orders says it is possible, then prudence would say it is certainly worth considering. Continued investment in America’s energy future is the clear and obvious answer.
About Chris Faulkner: Chris Faulkner is CEO of Breitling Energy Corporation (http://www.breitlingenergy.com/), author of “The Fracking Truth: America’s Energy Revolution” and producer of the documentary “Breaking Free: The Shale Rock Revolution”. Chris makes regular appearances on CNN, Fox Business and CNBC.