The New Oil Order

The New Oil Order

OPEC feels the squeeze from the U.S. shale boom.

America’s unconventional oil boom continues to yield major benefits—economic and geostrategic. The latest evidence is OPEC’s decision on Thursday to defy expectations and maintain its current oil production target despite the steepest price decline since the 2008-2009 recession. The price of Brent crude, the global oil benchmark, plunged as a result to about $70 a barrel, continuing its decline from a peak of nearly $116 in June.

Not too many years ago the Organization of Petroleum Exporting Countries might have cut production to maintain higher prices. The cartel’s countries have long sought to keep prices high at a level consistent with a growing global economy, not least to keep the revenue flowing into government coffers. Rogue states such as Venezuela and Iran desperately need the cash flow.

But the cartel has lost much of its pricing power thanks in part to the revival in U.S. oil production. Horizontal drilling and hydraulic fracturing—business innovations done mainly on private land—have pushed U.S. oil output to its highest level since the 1980s.

The Energy Information Administration says U.S. production reached more than nine million barrels a day this year and is expected to keep climbing. OPEC is afraid that demand for its crude will keep falling as U.S. supply continues to grow and more of it makes its way to the global market as American export barriers fall.

One way to read the OPEC decision is therefore as a price war to shake marginal U.S. producers from the market. The U.S. shale boom and high global oil prices have encouraged new areas of production with widely varying break-even price levels. Much of such proven areas as the Bakken Shale in North Dakota can remain profitable even at $50 a barrel, by most estimates. The Eagle Ford Shale in Texas also has a relatively low break-even. But newer areas with higher exploration and development costs could suffer if prices keep falling.

That’s how markets are supposed to work, with supply and demand rather than a cartel of dictatorships setting prices. A lower oil price will mean pain for some U.S. producers, and it is showing up in lower share prices for energy companies.

But no boom lasts forever, and lower prices will discipline American drillers to focus their investments on the most promising areas and innovate further to reduce costs. A shake-out might have long-term benefits if it doesn’t go too far.

Meanwhile, lower oil prices are an unmitigated boon to American consumers. The average gasoline price per gallon in the U.S. fell to $2.79 on Friday, down 50 cents from a year ago. That’s a big difference to the average family filling up the SUV each week, especially wage earners who haven’t had an increase in their standard of living during this entire economic expansion. Consumers who feel less pinched might open their checkbooks for non-energy purchases.

Lower prices will also add to the economic pressure on some of the world’s worst dictators, notably Vladimir Putin . Russia doesn’t belong to OPEC but it has benefited to the extent that the cartel’s production controls have kept prices high. Already under pressure from EU and U.S. sanctions, Mr. Putin’s ability to buy domestic political support will decline along with oil prices.

All of these benefits are flowing from a U.S. oil boom that government didn’t predict and had almost nothing to do with. The political class has force-fed subsidies to renewable energy with little economic benefit. The new oil order is a reminder that markets and American ingenuity are better economic pillars than all the schemes of government planners.

The entire article is from the Wall Street Journal and can be found at:  http://online.wsj.com/articles/the-new-oil-order-1417219168