OPEC should not be happy with oil at $60

OIL prices have edged little lower over the past two days from near $59, but that should not be bad news for OPEC. Rather, this is good news because it will help the market stay rebalanced. Last month, Venezuelan Oil Minister Eulogio Del Pino told reporters in Kuwait that when the Organization of Petroleum Exporting Countries (OPEC) agreed on the current production-cuts accord, they envisaged oil prices to be in the $60s not where they are now in the $50s.

There was a little disappointment in his tone about oil prices, but if OPEC is really concerned about the stability of the oil market, its members should not be happy about oil prices staying around or exceeding $60.

Many citizens of OPEC countries may reject this argument because the higher the better for fiscal budgets of the oil states — those who depend on oil as their main source of income.

But what fills the state coffers in the short term might lead to a deficit in the long term, if some of the forecast for nonOPEC increase in supply is accurate.

OPEC ministers always have problems in agreeing what constitutes a fair price even though OPEC has no ability to set prices in the market.

It can only influence prices or help other participants in forming a floor for oil prices at best.

It took a market crash for the group to realize that the old price of $100, which they enjoyed for almost four years, was not a good price.

Before the prices collapsed starting mid-2014, many ministers were talking about $100 as the new equilibrium price to the extent that even some US oil tycoons like T. Boone Pickens said in late 2014 that OPEC would try to re-obtain the $100 in a year.

Today, most OPEC ministers denounce the $100 and some of them behind closed doors have blamed the high oil prices for the recent collapse of the market.

Indeed, the high oil prices of 2011-2014 were behind the rapid growth in US oil production and mainly from tight oil deposits, which is better known as shale oil. But what most ministers are missing is that the market is so dynamic that they cannot comprehend how fast things are changing.

In less than two years, the industry adjusted to the fall in oil prices.

Many major international oil companies (also known as Big Oil) have lowered their operating costs, slashed capital expenditures, sold non-core assets, and changed the way they do business. Companies like BP or Royal Dutch Shell are now operating under the assumption that oil prices are “lower for lon- ger.” Shell is diversifying away from oil into other sectors like chemicals and renewables.

Shale oil companies in the US have also adjusted to the new reality, in which they played a huge part in shaping. They have applied every trick to stay in business from hedging to producing from drilled but uncompleted wells.

Every oil producer, except OPEC and a few other non-OPEC countries, showed their resilience to low oil prices. The result of that is they can still produce even when oil prices are half of what they used to be four years ago. Yet, no matter how resilient everyone is, shale oil companies cannot make enough profit this year even as oil prices at around $50 to $55.

With all the advances in financial engineering, the $60 of today can be as damaging to the stability of the market as the $100 of 2011-2014 because it will allow most of the high oil producers who exited the market to think about coming back again. This was obvious in the rise in hedging activities of shale drillers this year.

So it is in the best interest of OEC and its allies — who have pledged to cut 1.8 million barrels per day of their production between January 2017 and March next year – to see oil prices at $50-$55 because the market is still testing shale resilience to oil at $45-$55.

Some research firms like Bernstein sees $60 and more as the price that can support long-term development of US oil production.

Nonetheless, if international oil companies and shale oil drillers were able to financially engineer their way out through the current crisis, then OPEC’s survival rests on revolutionizing the way it sets its budgets.

However, achieving this is never easy for states that are addicted to oil, but without it surviving in the era of “lower for longer” is hard and OPEC will always be captive to its own creation: High oil prices.

Wael Mahdi is an energy reporter specializing on OPEC and a co-author of “OPEC in a Shale Oil World: Where to Next?” He can be reached on Twitter @waelmahdi

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