WHEN THE CURRENT DOWNTURN began more than a year ago, few in the petroleum industry thought we would still be struggling to overcome low prices and get back on track at this point in 2015. We've been through these cycles before, people said, and we'll start to dig ourselves out of the hole in six months or so. Maybe nine months. A year at the most.
Here it is nearly a year after OPEC's infamous "Turkey Day Meeting" in Vienna on Thanksgiving Day last November when the cartel announced it would not curb its production, as it had in the past, to give oil prices a shot in the arm. Instead, the group, led by Saudi Arabia, decided that market share was more important than oil prices. The apparent intent was to keep prices low in order to drive a number of shale producers in North America out of business, which the Saudis reasoned would reduce production from the upstart shale players in the United States and Canada and allow OPEC to retain market share. Because of the high costs of extraction, the shale producers would not be able to compete effectively with lower-cost Saudi crude, especially those with weak balance sheets.
The plan has not exactly worked to perfection because of the tenacity of American and Canadian E&P companies. Although some have failed, most are hanging in there. Borrowing bases have been reduced for some companies, but executives have found creative ways to continue drilling and producing by selling non-core assets and through the injection of private capital. They also have found ways to improve efficiency and reduce costs. Many have persuaded oil service companies to lower their prices as the market for their services shrinks.
To date, the failure of OPEC's strategy to get the shale producers to cry uncle has just extended the low-price agony for many. Although some of their colleagues in OPEC weren't thrilled with the Saudi plan, they prepared to endure an extended period of low commodity prices in order to keep their share of the pie.
Here we are nearly a year after the meeting in Vienna, and the Saudis haven't shown any sign of changing their position, although several members of the cartel have expressed exasperation with the tactics. Unlike Saudi Arabia, member countries such as Algeria, Nigeria, and Venezuela - just to name a few - don't have the huge cash reserves to sustain them when oil prices plummet. To keep revenues up, they are forced to produce more and more oil for export, which they sell at lower prices. Some observers think they are starting to see cracks in the cartel as some oil ministers have openly voiced their dissatisfaction with the policy.
The International Monetary Fund issued a dire report in October that said most countries in the Middle East will run out of cash in the next five years if oil stays around $50 a barrel. That includes OPEC leader Saudi Arabia as well as Oman and Bahrain. Low oil prices will wipe out an estimated $360 billion from the region this year alone, the IMF said.
Huge budget surpluses have begun to swing to massive deficits as oil prices hover at about $45 currently from a high of more than $100 in early 2014. Many governments in the region have been forced to tap into "rainy day" funds in order to weather the storm.
In addition, the depressed oil prices are occurring at a time when military and other spending has gone up as some of these countries grapple with regional violence and turbulent financial markets.
The IMF estimates that Saudi Arabia needs to sell its crude at approximately $106 a barrel to balance its budget. The kingdom has enough fiscal reserves to survive five years of $50 oil, the IMF says.
After years of huge surpluses, Saudi Arabia's current account deficit is projected to soar to 20% of gross domestic product this year. Although the Saudis have a war chest estimated at nearly $700 billion, it is shrinking fast in the current environment.
Other OPEC countries are having trouble surviving the current sub-$50 oil price environment as well. Iran's breakeven oil price is estimated at $72, the IMF estimates. However, the outlook for the Islamic Republic is clouded by potential sanctions relief (which hasn't come yet) and a surge in oil production after its nuclear deal with the West.
Iraq has virtually no fiscal buffer, according to the IMF. The country is battling Islamic State militants as it grapples with internal strife. Economic activity has been stunted by all this.
Bahrain needs $107 oil, says the IMF. The country has accumulated substantial debt and is already running deficits.
A few OPEC members are better positioned to weather the storm. Kuwait's breakeven oil price is estimated by the IMF at just $49, while the magic number is $56 in Qatar and $73 in the UAE. These countries have amassed vast amounts of oil money to sustain them during lean times. The UAE, for example, is said to have enough capital to withstand $50 oil for nearly 30 years.
So what impact will these financial realities have on OPEC? It's hard to say. So far, the Saudis are sticking by their strategy of holding on to market share regardless of the consequences. After a year, we are finally seeing modest production declines from US shale participants. However, in real terms, not much has changed. Although shale players would like to see the Saudis declare a victory and lower production levels, it will probably be a while before that happens.