Oil: Shale Tight Oil Disrupting The Paradigm? - Part 3

Summary

Discussion of OPEC market flooding costs and the potential consequences of production cuts.

Discussion of other potential motives for all-out production.

Brief analysis of shale tight oil costs and hidden cash flows.

Discussion of extent of the O&G market paradigm disruption caused by shale tight oil.

In case you missed it, in our last missive, Oil: Shale Disrupts The Cost Paradigm? Part 2, we:

• Examined IRR (internal rate of return) and payback time for various oil sources.
• Examined cash or shut-in costs.
• Examined upstream capital costs.
• Discussed potential disruption in the cost paradigm by shale tight oil.

In today's missive, we conclude this three-part examination of a disrupted paradigm with OPEC market flooding costs; the consequences of potential production cuts; other potential motives for all out production; shale tight oil costs; and the extent of oil and gas market paradigm disruption caused by shale tight oil.

OPEC Market Flooding Costs

Saudi oil is 45% of GDP, 90% of all exports; and bankrolls 80% of the government's budget. IMF estimates SA will run a budget deficit of about $140B in 2015, or 20% of GDP. YTD, SA has spent $60B in FX reserves, which, at $672B, are eroding at $12B a month. SA has borrowed $10B and will borrow another $27B in debt markets. This does not factor in its currency (riyal) devaluation vs. dollar. With $670B in FX reserves, the Saudis can wage a decade-long production jihad. Its OPEC partners? Only Kuwait's budget can breakeven at current prices.

What is more important to Saudis/OPEC? Temporary budget deficits while wiping out non conventional/shale and squeezing non-OPEC (Russia)? Or temporary profits?

Consequences Of Production Cuts

The Saudis are pumping 10.6Mbd, and under theory, if OPEC cuts production and prices temporarily rise, shale drillers would increase production, and prices would then fall back.

An OPEC production cut would mean lower long-term revenue, and an OPEC production increase would mean lower short-term revenue, resulting in fewer shale drillers/shale wells, which would result in higher long-term revenue.

Looking at the logic loop: production decrease = price increase = petrodollar/eurodollar increase (volume) = dollar decrease = price increase. Self-reinforcing loop, wash, rinse, spin, repeat. Until the price reaches the point where shale production would rise, reverse the above polarities for a production increase.

IMHO, given OPEC lifting costs under $10/bbl, it wants to terminate the competition with extreme prejudice. Any discussion with Russia aside, as it does not benefit the Saudis or OPEC, it would seem that no production cuts would be coming anytime soon. And don't forget the unwritten deal, the US provides "security" as long as the Saudis invest their excess petrodollars in USTs and denominate the world price of oil exclusively in dollars.

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