This post comes in complement of our previous article “Game of oil“, where we analysed the Saudi Arabia’s oil strategy and its geopolitical goals. This time, we will analyse the impact of falling oil prices on US oil production to assess whether or not Saudi’s Arabia’s strategy to “kill” the American oil and gas shale industry has been successful.

The US shale oil and gas boom started in 2008, with the effects on the production clearly appearing from 2010 onward. As illustrated in the figure 1 below, the US oil production has been continuously increasing since then, with the US contributing to 60% of the worldwide incremental growth of oil production between 2010 and 2015. The figure 2 shows the evolution of market share per country: the US (already the world’s largest oil producer) increased its market share while Saudi Arabia and the other OPEC members suffered from the ramp-up of the American production and saw their market share slightly decline in 2013-2014.

2010-2015 oil production change

With the stated goal to recover its market share and stop the rise of the US, Saudi Arabia, backed by the OPEC, decided to increase their production at the end of October 2014. The goal was to create an oversupply to drive down prices, thus making the shale oil and gas business unprofitable and less attractive for US producers, and eventually resulting in a decline of the North American output. On figure 1, we can see a surge of the production in Saudi Arabia and OPEC for the 10 first months of 2015. However, despite a declining growth, the US kept increasing their production and their market share reached 15% over the same period.

World oil production market share

If Saudi Arabia decided to drive down prices, it is because, both in the short and in the long run, there is a very strong correlation in the US between the oil prices and the rigs count, as seen on figures 3 and 4.

US rigs & WTI spot price

4 US rigs & WTI spot price 1986 2016

Indeed, from these graphs, we can observe that the drop of oil prices led to a dramatic decline of the rigs count in the US; still, the US oil production remains quite resilient and the US continued to increase their production in the first half of 2015. As illustrated in the figure 5 below, even if the American oil production has been declining since July 2015, the output remains very high when compared to the slump in the rigs count. This limited output decline can be explained by the following reasons:

  • The best equipment have been shifted from the smallest and less profitable oil fields toward the biggest one in order to reduce extraction costs and increase production, enabling companies to make the production profitable even with lower prices.
  • Technological improvement in the shale oil and gas industry improved the recuperation rate of the existing fields, thus increasing production and reducing operating costs.

Nevertheless, since July 2015 the US oil production has been declining and since January 2016, the drop is accelerating. One reason may be that existing fields are depleting while oil prices are still too low to launch new drilling. Therefore, the American oil production is expected to continue its fall in coming months.

5 US oil rigs and oil production

In the light of these facts, Saudi Arabia’s strategy results appear mixed. The slump of oil prices actually led to a collapse of the rigs count in the US but the start of the decline in production took time and, 18 months after the prices start falling, the drop is rather limited (in the last week of April 2016, the American oil production was only 1.6% below the level recorded at the end of October 2014).

Moreover, to force the American producers to reduce their production, Saudi Arabia had to accept oil prices that probably were much lower than initially expected; according to the CEO of an oil company, Saudi Arabia did not expect that oil prices would drop below USD 70. As of May 2016, prices are still under USD 50 and fell below USD 30 in February 2016. This decline had a huge negative economic impacts for Saudi Arabia and other major oil exporters and it created tensions within the OPEC regarding the oil policy.

Since mid-February 2016, oil prices have been increasing and are now around USD 45. If we refer at the figures above, it appears that the trend of oil prices needs around 3 months to be translated in the rigs count and around 90 months to impact the effective oil output. Thus, as prices have been increasing since February, the rigs count in the US could stabilize and start raising as soon as the end of May 2016; if this happens, the US oil output could stop falling by the end of this year.

This is highly possible as shale oil production is rather flexible and because there is a huge number (estimated around 3,000) of drilled uncompleted wells (DUCs) which would be the cheapest mean to quickly increase the production; analysts expect that DUCs could start operating at USD 50-55 per barrel.

As a result, unless Saudi Arabia is ready and able to live with ‘permanently’ low prices of oil (defined as USD 50 maximum per barrel), it will have to accept the US as a resurgent oil producer and the geopolitical shifts that this fact entails.

Thank you for reading. For further information regarding oil as a tool for geopolitical goals, you can refer to our previous article: Game of oil: Saudi Arabia’s massive geopolitical bet

About Nicolas Houilliez

Luxemburg based with strong analytical skills, I worked as market and strategy analyst in large multinational companies. Passionate about China, economics, geopolitics and finance.