Authored by Salmon Ghouri via OilPrice.com,

Time is of the essence. If you fail to comprehend future market conditions and fail to steer the ship in the right direction, it can lead to disaster. This is what we have learned during the past few years. OPEC’s failure to understand the future market conditions and speed of technological advancements has resulted in economic setbacks.

A 2012 paper about the role of U.S. shale oil in global oil markets suggested that “It could be in the interest of OPEC to already increase its production now and allow oil prices to decline to below $60 to discourage further development of shale oil”. The industry, and more particularly OPEC, continued with their “business as usual” strategy, unaware of the dramatic impact U.S. shale would have on oil prices.

$100+ oil prices allowed companies to master the fracturing technology. As a result, the shale industry was able to increase average productivity per well by employing advanced horizontal drilling techniques, multi-stage fracturing and concentrating towards the most productive areas of the basin. For example, oil productivity per rig for the Bakken increased from 112 b/d in January 2007 to 746 b/d in March 2016 – over 6.6 fold increase. Improvements were also made in terms of Estimated Ultimate Recovery (EURs) which in some of the basins reached 50 to 60 percent in 2015/16.

The higher U.S. shale oil production started to take its toll on oil prices in the second half of 2014. To counter the new enemy (shale oil), OPEC, contrary to its traditional tool of curbing its own production, flooded the market for an extended period of time, explaining that it was merely defending its own market share and assuming that such policy would incur permanent damage to the U.S. shale industry.

Having executed this strategy for over 2 years, OPEC realized that the continuation of such a policy was quite detrimental to the economies of its members. Most OPEC members had to take some unpopular decisions to curb government expenses, including downsizing, drastic cost cutting measures, removing subsidies and cancelling megaprojects. All these efforts provided them with some breathing space and also avoided complete economic collapse.

Eventually, OPEC reverted back to their old wisdom of cutting oil production, which saw oil prices creep up to the mid-fifties. The oil bust taught them a good lesson and made them realize how dependent their economies are on oil revenues. A good example of this is the Saudi Vision 2030 diversification plan, which is aimed at reducing reliance on oil income.

Oil prices around $50 might provide some relief for OPEC countries, U.S. shale producers directly responded and the number of drilling rigs substantially increased in the last couple of months. And now the U.S. shale patch has brought break-even costs per barrel down even further, Shale oil production could even increase as oil prices fall below $50 per barrel again.

Offering some clues on how the cartel could defend its market share, an article by the author, published last year on Oilprice.com forecasts the responsiveness of U.S. shale oil production against various oil price scenarios.

In the base scenario, if oil prices gradually increase to $78/bbl, than by December 2020, total U.S. shale oil production from the given seven basins would increase to 6.79 MMBPD – an increase of 37 percent compared to March 2016. In contrast, under low oil price scenarios (range of mid thirties and mid twenties), shale oil production would decline in all the basins and by December 2020 would fall to 3.03 MMBPD, a decline of 67 percent compared to March 2016.

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The hard lesson learned during the past few years is that due to technological advancements, U.S. shale oil producers can lower their breakeven prices and challenge OPEC’s market dominance.

One strategy, if OPEC aims to harm U.S. shale oil producers, is to stop intervening in oil markets, provoking a drastic fall in oil prices – possibly back to $30 per barrel. Such a drop in crude prices could crash shale oil production in almost all the seven U.S. basins. By the end of 2020, their cumulative production could fall down to 3.03 mmbpd. This could potentially evaporate excess global supply, however, this strategy will once again have a devastating impact on the economies of individual OPEC members. As such, OPEC are unlikely to initiate such a self-defeating strategy.

Higher oil prices of over $60/bbl on the other hand, will allow most of the seven shale oil producers to increase production, keeping oil prices in a narrow range. In such a scenario, oil prices within the range of $50 to $60/bbls will balance the global demand/supply and will not be detrimental to either producers or consumers.