The OPEC v. Shale Oil “Staring Contest:” Did OPEC Just Blink?

This post is also available at my LinkedIn page.

So here we are – yesterday news leaked that OPEC is finally going to cut their combined production and install a 32.5 million barrels/day ceiling. As most readers likely know, oil prices have largely languished in the sub-$50 range for nearly two years aside from a few instances of coming up for air. The pain has been real for all oil and gas companies both foreign and domestic – Houston is a shell of itself, whereas Riyadh has had to dramatically reduce its heretofore extravagant funding of various social programs. While it might potentially be a milestone moment in retrospect a few years from now, I would caution against any industry-wide metaphorical spiking of the football – at least for a little bit.

First, there’s an age-old axiom that “the devil is in the details.” Although the OPEC principals have agreed on a cut, the details as to how the cut will be borne appears not to have been agreed upon yet. This is obviously noteworthy given Iran’s petulance and refusal to agree to shouldering any part of a cut in light of getting its own production going again following lifting of U.S. sanctions.

Second, we saw what happened in mid-2015 when we as an industry thought the bottom was in and the recovery was in full swing – producers opened their spigots and met the demand increase so quickly that it deflated the commodity’s price in global trading from then on to present. There’s no reason to think that U.S. shale firms will not take this as a mandate to double-down on their drilling efforts. Even before this announcement, many companies have been starting to get more active in preparation for a perceived recovery. Where I am in the Permian Basin, activity was on a slow uptick for several months; in the past month or two, though, the uptick is more pronounced and will likely continue in earnest.

Third, demand is still just as crucial a part of the overall equation as supply. At the risk of coming off as a faux analyst, it seems to me that the most important variable is China. It seems that every quarter the numbers and predictions on forecast Chinese demand oscillates back and forth. Strong demand in China would soak up what I perceive as additional U.S. oil hitting the market in the coming months and years, and weak demand would lay the foundation for prolonged pricing around $50/barrel. For now it is a variable that nobody can predict with certainty, and we’ll have to see what happens.

Finally, last year I got up on my bully pulpit (i.e., my blog and LinkedIn page) and said that 2016 would see a flurry of M&A and §363 bankruptcy sales given the over-levered status of many companies in our industry. While there have been plenty of bankruptcies, mergers, and acquisitions, it seems that financial institutions and lenders did not come down as hard on mortgagors who were substantially drawn on the revolving credit facilities – sure, plenty of borrowing bases were reduced, as any CEO or CFO would be quick to tell you. It’s said that the ashes from the fires of bankruptcies sow the seeds for the next boom, and I don’t feel like those fires burned nearly hot or long enough – this is not to say I am at all rooting for more companies to bail out, be forced to sell assets, and layoff their workers, but it is not certain that the industry as a whole has gone through the requisite catharsis necessary to have sown those seeds. In the end, many companies were able to get by – some at an amble, some with a limp.

It’s better news than no news, or bad news – let’s all be reasonably optimistic with a dash of healthy skepticism.