The biggest game of chicken in the history of business

A high drama is playing out on the stage of the world’s economy, one that will affect everyone, except, perhaps, a few tribes in the remote reaches of the Amazon or New Guinea that do not participate in the cash economy. The global economy is powered by oil, and a titanic power struggle over control of that supply is underway.

For roughly 4 decades since the 1973 Arab Oil Embargo, OPEC has called the shots and extracted trillions of dollars from the rest of the world by forcing oil prices to huge multiples of the cost of production for Saudi Arabia and other Middle Eastern countries like the Emirates, where holes can be punched in the desert and oil risen to the surface for a few dollars a barrel, and until recently, sold for over a hundred.

But the price umbrella that OPEC provided opened up the possibility of new sources of oil being developed with higher cost technologies like horizontal fracturing or refining Athabascan tar sands in Alberta. Rapid technological progress in these technologies has resulted in a glut of supply coming on line and driving prices down to current levels, roughly $70 a barrel. And on Thursday, OPEC declined to cut production, as it has so often done in the past, to firm up prices.  Traditionally, Saudi Arabia has acted as the swing producer, with enough financial reserves to cut production when necessary to raise prices to the target level, and with enough reserve capacity to expand production and drive down prices when necessary to manage the market to its own desired price levels (so as to discourage too much new production – as has happened in the past several years).

Now, with huge new oil fields developing in Bakken, Eagle Ford, Marcellus, and other North American sites, OPEC’s share of world oil production has declined to a level at which price control becomes problematic. So a game of chicken is underway. OPEC is allowing prices to fall to a level at which some new technology sites may not be able to operate profitably, and will have to be closed down.  Because it is both expensive and time-consuming to resume production once an oilfield is shut down, once the new competition is drive out, oil prices can once again be driven up, and OPEC members, including such worthies as Iran and Venezuela, can once again prosper, although they will go through a rough patch during the period of low prices. While Saudi Arabia and Abu Dhabi can just draw down financial reserves to skate through, in Venezuela and Iran, large numbers of people will suffer the loss of subsidized food, energy and other necessities, possibly endangering the regimes’ stability. Russia is greatly dependent on energy production to finance its military build-up, and the oligarchs backing Putin are already suffering from the oil price decline.

So, who will blink in this game of chicken?

Ed Morse, an analyst working for Citi, has compiled an invaluable chart of the breakeven cost of production for all the major new oilfields, and it can act as a map to which of them will have to close down if low oil prices persist or decline even further.  Miles Udland of Business Insider writes:

And now that oil prices have fallen more than 30% in just the last six or so months, everyone wants to know how low prices can go before oil projects start shutting down, particularly US shale projects.

In a note last week, Citi's Ed Morse highlighted this chart, showing that for most US shale plays, costs are below $80 a barrel. 

Morse writes that if Brent price move towards $60 — they're currently around $72 — a "significant" amount of shale production would be challenged.

But Morse also highlighted this dizzying chart, listing the breakeven price for every international oil company project through 2020. (You can save it to your computer and zoom in for a closer look.)

 

These charts tell you what to watch for in this game of chicken, who is likely to cry uncle first.  Fasten your seatbelts, we’re in for a bumpy ride.

A high drama is playing out on the stage of the world’s economy, one that will affect everyone, except, perhaps, a few tribes in the remote reaches of the Amazon or New Guinea that do not participate in the cash economy. The global economy is powered by oil, and a titanic power struggle over control of that supply is underway.

For roughly 4 decades since the 1973 Arab Oil Embargo, OPEC has called the shots and extracted trillions of dollars from the rest of the world by forcing oil prices to huge multiples of the cost of production for Saudi Arabia and other Middle Eastern countries like the Emirates, where holes can be punched in the desert and oil risen to the surface for a few dollars a barrel, and until recently, sold for over a hundred.

But the price umbrella that OPEC provided opened up the possibility of new sources of oil being developed with higher cost technologies like horizontal fracturing or refining Athabascan tar sands in Alberta. Rapid technological progress in these technologies has resulted in a glut of supply coming on line and driving prices down to current levels, roughly $70 a barrel. And on Thursday, OPEC declined to cut production, as it has so often done in the past, to firm up prices.  Traditionally, Saudi Arabia has acted as the swing producer, with enough financial reserves to cut production when necessary to raise prices to the target level, and with enough reserve capacity to expand production and drive down prices when necessary to manage the market to its own desired price levels (so as to discourage too much new production – as has happened in the past several years).

Now, with huge new oil fields developing in Bakken, Eagle Ford, Marcellus, and other North American sites, OPEC’s share of world oil production has declined to a level at which price control becomes problematic. So a game of chicken is underway. OPEC is allowing prices to fall to a level at which some new technology sites may not be able to operate profitably, and will have to be closed down.  Because it is both expensive and time-consuming to resume production once an oilfield is shut down, once the new competition is drive out, oil prices can once again be driven up, and OPEC members, including such worthies as Iran and Venezuela, can once again prosper, although they will go through a rough patch during the period of low prices. While Saudi Arabia and Abu Dhabi can just draw down financial reserves to skate through, in Venezuela and Iran, large numbers of people will suffer the loss of subsidized food, energy and other necessities, possibly endangering the regimes’ stability. Russia is greatly dependent on energy production to finance its military build-up, and the oligarchs backing Putin are already suffering from the oil price decline.

So, who will blink in this game of chicken?

Ed Morse, an analyst working for Citi, has compiled an invaluable chart of the breakeven cost of production for all the major new oilfields, and it can act as a map to which of them will have to close down if low oil prices persist or decline even further.  Miles Udland of Business Insider writes:

And now that oil prices have fallen more than 30% in just the last six or so months, everyone wants to know how low prices can go before oil projects start shutting down, particularly US shale projects.

In a note last week, Citi's Ed Morse highlighted this chart, showing that for most US shale plays, costs are below $80 a barrel. 

Morse writes that if Brent price move towards $60 — they're currently around $72 — a "significant" amount of shale production would be challenged.

But Morse also highlighted this dizzying chart, listing the breakeven price for every international oil company project through 2020. (You can save it to your computer and zoom in for a closer look.)

 

These charts tell you what to watch for in this game of chicken, who is likely to cry uncle first.  Fasten your seatbelts, we’re in for a bumpy ride.