oil price
Oil: It's Now a "Survival of the Fittest" Situation
Thanks for all the positive (and even the not so positive) feedback regarding last Friday's deeper look at the reality of the recent plunge in oil prices.
I know we've mentioned this before, but it bears repeating now...we read every e-mail you guys and gals send us, and where it's appropriate, we respond. Sometimes we respond right here in the newsletter, if it's an answer that will do everybody some good. We're still sifting through all the responses to Friday's commentary, so we don't have a public response to anything specific just yet. We do have abroadresponse we want to serve up to you though, based on your questions and comments. Here goes.
While on the surface it looks like OPEC is just pressing our buttons by not lowering their oil output to buoy crude's price, truth be told, the Saudis and most of the Middle East can afford to do so.If it comes down to a price war between OPEC, Russia, and the United States, the U.S. and Russia will flinch first.
Why?It's just simple economics.
Consider this the proverbial "rest of the story" to Friday's newsletter. The fact of the matter is,there ain't nobody in the world that can drill for oil as cheaply or as easily as most OPEC countries can. On the flipside, there are some American explorers and producers that can get pretty darn close.
The figures vary slightly from one source to the next and from one year to the next, but generally speaking, the Middle East's onshore oil production costs are only about $30 per barrel. Most other onshore production costs at other places on the globe are about $50 per barrel. The average cost to produce a barrel of shale oil in North America is an average of about $65[though I want to come back to this factoid in a moment],and the typical oil sands operation costs about $75 per barrel. As of last week, the average shale operation was just breaking even, and some oil sands sites were operating in the red.This chart from Rystad Energy of Morgan Stanley's figuresillustrates all the various cost structures by geography
This graphic I believe came from the IEA, though my source wasfinancialsense.comand they didn't attribute it as far as I could tell. (Click on the chart for the full-sized version.)
Whoever made it, the story is the same - Saudi Arabia only pays about $25 bucks to extract a barrel of oil, and the rest of the OPEC countries only pay about $36 dollars. Russia only has to spend about $48 to lift a barrel of oil. The average oil drilling cost for the United Statesnot counting shale oilis about $42 per barrel. After that, costs go up to more than $70, with Canadian oil sands at the extreme end of the cost scale. U.S. shale operations tend to be at the high end of the cost scale on this chart too, with a typical cost of about $65 per barrel.
Now, there's one point I want to make now and one I want to make in a moment. The first key point is,OPEC can afford to play a game of chicken with oil prices a lot longer than we can.Will they?I don't know, but they can. Russia isn't exactly empty-handed on this front either. Don't be shocked if OPEC sustains this game, if only to shut down at least some of the United States output that will inevitably be shuttered simply because it makes no sense to produce oil at a cost greater than its market price. That's good for consumers, but bad for oil explorers and producers.
The other point I want to make: While it may cost $65 on average to extract shale oil,the difference in costs from one shale operation to another is crazy.Some are already operating in the red, while others right here in the United States couldn't care less that oil prices have dropped to the mid-$60's.
Take a look at the chart of average costs of different types of oil production in the United States. The data was provided by Barclays, Deutsche Bank, Citigroup, and IHS Herold, andpresented by the Financial Post here. Oil shale in the U.S. requires as little as $40 to as much as $80 to extract one barrel. While several of the types of sources for oil have similarly cost ranges, given how much of our "new" oil here in the United States comes from shale, this wide disparity in costs means the shale mining industry in the U.S. is hypersensitive to fluctuations in oil prices. More directly, it means some shale oil operations in the United States may not be profitable again for years, while others could remain profitable indefinitely despite wickedly-low oil prices.
Now I'm not able to track down the cost structures for every shale oil operation in the U.S., but I will point you to thisopinion posted by Reuters in October, which shows the estimated breakeven prices for most of the major shale oil sites in the country. Even the estimates vary widely from any analytical team to the next, but in the aggregate you should be able to get a good feel for actual costs by locale.
That said,the viability question doesn't have to just be asked of shale miners.A whole lot of drillers and explorers are on the bubble. While this may be bad for all of them in the short run, for the low-cost drillers, a culling may actual prove to be quite fruitful in the long run.