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A strategically bad week for oil

This was a bad week for oil, but most people in this industry are having trouble remembering a good one.

The slump in prices has led to revisions to earnings per share for the world’s ten largest integrated oil companies. This week, oil fell to its lowest in six years. What affects the news is simple enough: OPEC is not planning on curving production, and there is a serious oversupply.

It is all about demand. The global economy is growing at 3,1% in 2015, with growing demand being 1,53 million barrels a day. Tumbling oil prices are boosting consumer spending in certain economies, such as the US, but denting revenue for oil producing economies that are losing investment and employment. But, those that gain market share today may live to enjoy it in better days, when prices go up. Those who go under now, they may stay down for a very very long time. That is the thinking at least.

On Monday, the U.S. Energy Information Administration released a Drilling Productivity Report for the U.S. producers of oil and gas in the shale formations across the United States. What was clear from the report was that many shale companies have large reserves, face tumbling oil prices, and can no longer produce for under $40 a barrel. They are closing down. Interestingly, many of those companies eager to get higher valuations to invest in production in the good old $95-barrel days counted undrilled oil as reserves, which took some serious lobbying to do. Now, many of the undrilled-reserve oil will not be drilled after all.

Bloomberg estimates $1,1 bn barrels of oil could be wiped out in a split of a second. That also means fracking has hit a serious break in the United States. That production is not likely to recover any time soon. Many companies are going down, with defaults that will hurt banks and investors. Many of those companies are going from first-rate investment grade to junk so fast; that will make people want to discuss rating the rating agencies again. Shale production in many regions has a very low $50 break-even production price. That constitutes an immense productivity gain in a very short period, as the break-even prices were $70 not so long ago. That means that these companies could one day return to production, but the chances are that very few have the cash to withstand a prolonged period of under $40 a barrel price. Bad days are looming in places in Dakota and Texas.

On Thursday, OPEC published its Monthly Oil Market Report, highlighting production figures for Saudi Arabia and other major oil producers in the group. OPEC’s decision to keep pumping will probably bring tears to the eyes of many finance ministers in oil-producing countries and will drive many shale producers out of business sooner rather than later. What is critical here is that the share of non-OPEC countries in oil production is decelerating faster than anticipated. It is not the US alone; it also Canada, Mexico, and Australia that are reducing production faster than expected.

What OPEC and especially Saudi Arabia have on their side is low production costs. In 2016, production by non-Opec producers is expected to decline further by 380,000 barrels a day. In sum, this is a long-OPEC game pushing out competitors out of the market that will be unable to recover for quite some time. Saudi Arabia now is after a bigger market share, not more oil revenue. This is one objective very few have the power to pursue, in a world usually dominated by shareholder and dividend concerns.