2019 promises a tug of war between shale and Opec+

All bets are off as US shale producers look set to take an aggressive stance towards production in 2019.

After years of strategic spending to boost production and market share, US shale producers have made strong strides in returning healthy profits. New algorithms and drilling techniques are revolutionising the cost, efficiency and speed at which oil can be extracted. This modern-day gold rush is already turning ambitious engineers in west Texas into multimillionaires.

Next year looks set to power the shale revolution even more. Increasing productivity, lower tax rates and access to low-cost funding will drive the cost of fracking ever lower.

Thanks to US shale, Opec+, the group comprising Opec and other allies led by Russia, is caught between a rock and hard place. Nearly every single Opec+ member is facing large fiscal deficits in 2019, meaning they need oil prices to be as high as possible to meet their financing requirements. The obvious way to drive oil prices up is to cut production.

This is precisely how Opec+ has responded to oil market volatility, agreeing in early December to a further round of production cuts. It took two strenuous days of wrangling but Opec+ confirmed a reduction of 1.2 million barrels per day from October levels, to last for six months, with a review scheduled in April 2019. The ambition is to rebalance the oversupply in oil markets.

The decision shows just how important oil prices are, as Opec+ sacrifices market share in return to ensure prices remain high in the first half of 2019. Helped along by further declines in Iranian and Venezuelan oil production, Opec+ seems to have done enough for now. However, potentially higher oil prices won’t hold for long – spring will come around all too quickly for Opec+.

Members of the group know all too well what this means for US shale. Khalid Al Falih, the Saudi Energy Minister, declared that “US producers will be breathing a sigh of relief” following the Opec+ agreement to cut production. Shale producers have already beaten expectations in 2018, now Opec+ is giving them even more of an incentive to hit their targets in the new year.

Mr Al Falih said in Riyadh this month that he was certain the alliance will continue to trim production when the current agreement comes to an end in four months’ time, saying: “We need more time to achieve the result.” The concern is that this will only provide more time for US shale to maximise their output and gain further market share.

The prospect of higher oil prices also benefits shale producers, helping them improve their balance sheets and fund more investment into increasing production and efficiency.

What does this all mean for oil prices if Opec+ are trying to push them higher in the face of intense pressure from the US?

Brent oil prices reached a record high in October at $86 per barrel, their highest level since November 2014. It then precipitously fell to its lowest point at just above $50 per barrel. These wild volatile lurches are likely to continue going into 2019 as US shale producers put all their efforts into winning the tug of war.

Opec+ faces other pressures too, which mean its rope is already fraying. On the demand-side of the equation, US-China trade tensions are slowing global growth, the Federal Reserve has signalled that it plans to slow the pace of hikes in 2019 and Chinese President Xi Jinping has offered no new reforms to stimulate the world’s second largest economy.

Opec+ has very little influence over any of these, all of which are likely to curb the global appetite for crude. If they do, prices will go lower despite Opec’s best efforts.

While most investors deem that action by Opec+ to curb a further 1.2 million bpd from the market may be enough to lift prices in the nearterm, in tandem, US shale is likely to continue growing at a remarkable rate. This will hamper Opec+ countries with the prospect of an endless iteration of cuts that simply results in them making way for shale. However, Opec+ may get some respite in mid-2019, if the US turns more hawkish and toughens more Iranian crude off the table, which will likely prop up oil prices somewhat.

Heading into 2019, Opec+ producers are increasingly coming to terms with the resilience of the shale industry and adopting the mantra that if you can’t beat them, then learn to live with them. Shale has established itself as the firm global swing oil producer. It’s hard to see it coming second place.