Texas shale oil has fought Saudi Arabia to a standstill
Opec's worst fears are coming true. Twenty months after Saudi Arabia took the fateful decision to flood world markets with oil, it has still failed to break the back of the US shale industry.
The Saudi-led Gulf states have certainly succeeded in killing off a string of global mega-projects in deep waters. Investment in upstream exploration from 2014 to 2020 will be $1.8 trillion less than previously assumed, according to consultants IHS. But this is a bitter victory at best.
North America's hydraulic frackers are cutting costs so fast that most can now produce at prices far below levels needed to fund the Saudi welfare state and its military machine, or to cover Opec budget deficits.
Scott Sheffield, the outgoing chief of Pioneer Natural Resources, threw down the gauntlet last week - with some poetic licence - claiming that his pre-tax production costs in the Permian Basin of West Texas have fallen to $2.25 a barrel.
"Definitely we can compete with anything that Saudi Arabia has. We have the best rock," he said. Revolutionary improvements in drilling technology and data analytics that have changed the cost calculus faster than almost anybody thought possible.
The 'decline rate' of production over the first four months of each well was 90pc a decade ago for US frackers. This dropped to 31pc in 2012. It is now 18pc. Drillers have learned how to extract more.
Mr Sheffield said the Permian is as bountiful as the giant Ghawar field in Saudi Arabia and can expand from 2m to 5m barrels a day even if the price of oil never rises above $55.
His company has cut production costs by 26pc over the last year alone. Pioneer is now so efficient that it is already adding five new rigs despite today's depressed prices in the low $40s. It is not alone.
The Baker Hughes count of North America oil rigs has risen for seven out of the last eight weeks to 374, and this understates the effect. Multi-pad drilling means that three wells are now routinely drilled from the same rig, and sometimes six or more. Average well productivity has risen fivefold in the Permian since early 2012.
Consultants Wood Mackenzie estimated in a recent report that full-cycle break-even costs have fallen to $37 at Wolfcamp and Bone Spring in the Permian, and to $35 in the South Central Oklahoma Oil Province. The majority of US shale fields are now viable at $60.
This is a cold douche for Opec. It has been an article of faith among Gulf exporters that hedging contracts had kept US shale companies on life-support and that there would be a brutal cull as these expired in the first half of this year.
No such Gotterdamerung has occurred. A few over-leveraged players have gone bankrupt, but Blackstone, Carlyle and other private equity groups are waiting on the sidelines to buy distressed assets and take over the infrastructure.
The crucial mid-tier drillers have weathered the downturn. Many are still able to raise funds at low cost. Total output in the US has fallen by 1.2m barrels a day to 8.5m since the peak in April 2015 but production has been bottoming out. Today's frackers can just about cope with oil prices in the $40 to $50 range.
Opec may now have to brace for a longer war of attrition than they ever imagined. Global inventories of crude oil remain near all-time highs, record volumes are being stored on tankers off-shore.
Forest fires in Canada, rebel attacks in Nigeria, and other global upsets took 4m barrels a day off the global market at one stage over the May-June period, masking the continued world glut. These disruptions are subsiding. Lost output has dropped to nearer 2m barrels a day. That is a key reason why US crude prices have fallen 20pc to $41 over the last six weeks.
Morgan Stanley says the long-awaited rebalancing of the global markets has been delayed for yet another year until mid-2017.
Worse yet for Opec, consultants Rystad Energy say that 90pc of the 3,900 drilled but uncompleted wells - so-called 'DUCs' - are profitable at $50. This implies an overhang of easy supply waiting to hit the market. Citigroup expects an extra 1m barrels a day in late 2016.
Once that is cleared, shale drillers will have to build new rigs. Mr Sheffield said Pioneer can do this is 135 days flat, a dramatic contrast to deep-water mega-projects that can take seven to 10 years.
This agility has changed the nature of the oil cycle. It means that Opec faces an unprecedented headwind from mid-cost producers. Stalwarts Anadarko and Hess say they will wait for $60 before investing heavily, but they are already preparing the ground.
The losers are high-cost projects elsewhere: off the coast of Nigeria and Angola, in the Arctic, or the oil sands of Canada and Venezuela's Orinoco basin. Roughly 4m to 5m barrels a day of future supply has been shelved around the world.
This sets the stage for an oil shortage and a price spike later this decade. Whether Opec can survive that long is an open question. Most of the cartel need prices of $100 to fund their regimes.
Venezuela is already in the grip of hyperinflation and food riots. Nigeria's currency peg was smashed last month, and the naira has fallen 60pc. Angola has turned to the International Monetary Fund, Azerbaijan to the World Bank.
Saudi Arabia has deeper pockets but its net foreign reserves have fallen from $737bn to $562bn, even though it is borrowing money abroad to slow the loss. It burned through another $11bn last month.
Riyadh is trying to curb the country's culture of subsidy and entitlement, but was forced to sack a minister and backtrack after a 500pc rise in water prices set off an outcry. It is the famous social contract from cradle-to-grave that keeps the House of Saud in power.
The IMF says the budget deficit will be 13pc of GDP this year, but nobody really knows since true military spending is secret and subsidies for Egypt and a nexus of clients in the Saudi sphere are opaque. Riyadh probably has a safe reserve buffer for another eighteen months at current oil prices before perceptions change and capital flight turns serious.
If West Texas really can boost output by another 3m barrels a day at anywhere near $55 a barrel - as Mr Sheffield claims - the Saudis may have to dig in for a very long and painful siege.
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