Fracking

Experts: Fracking Industry Likely to Crash Due to OPEC Decision to Keep Oil Production High

Welcome back to the geopolitics of the oil industry.

Increased production by the U.S. oil industry and a recent decision by the Organization of Petroleum Exporting Countries to maintain current levels of production could result in a crash in the domestic shale oil industry. A glut of oil, resulting in a drop in market prices, might make investment in new fracking operations unprofitable, energy industry insiders say.

The recent fall in the price of oil is only partially about supply and demand. Instead, it's about how OPEC is responding to the threat that U.S. oil production, particularly cost-intensive fracking, poses to its preeminence in global oil markets.

Oil tycoon Leonid Fedun told Bloomberg News that OPEC’s policy on crude oil production will ensure the U.S. fracking boom will eventually crash. Fedun, a billionaire board member of Lukoil, Russia’s second biggest oil producer, said OPEC's objective is “cleaning up the American marginal market,” and that when it's successful the price of oil will once again rise.

“The shale boom is on par with the dot-com boom,” said Fedun. “The strong players will remain, the weak ones will vanish.”

At a meeting in Vienna on Friday, the 12 OPEC nations agreed to keep output targets unchanged at 30 million barrels a day despite a 35% slump in prices since June. Strong competition from North American oil producers, especially U.S. shale fields, has caused a surge in supply. A decrease in global demand is also behind the falling prices.

While fracking operations in the U.S. will add about 1 million barrels of oil a day in 2014, American oil producers might become victims of their own success. Should the price of a barrel of oil, which stands near $70 a barrel today, drop any further, it could threaten financing for shale exploration and trigger rapid market consolidation. Much of the recent increase in fracking is funded with borrowed money.

"I think the lending to companies that are going to drill that kind of well is going to stop. Right now," Philip Verleger,  an economist and energy industry consultant told USA Today. "There's going to be no more cash into these companies from the outside."

While it's hard to pinpoint how much it costs to produce a barrel of fracked oil in the U.S., Norwegian oil consultancy Rystad Energy says it costs an average of $62 a barrel in much of the U.S. Oil extraction in the Arctic costs $78 a barrel on average and Canada's oil sands oil costs $74 a barrel. The prices vary by region and company, so some companies may actually have much higher costs, which means they might be producing oil at a loss. By contrast, it costs less than $30 a barrel to produce oil in the Middle East. 

Industry analysts are already lowering expectations for U.S. energy markets, with some forecasting oil will drop to $68 a barrel by early 2015.

Oil futures are at their lowest in four years. U.S. oil producers are only continuing to thrive at the moment because they already have previous arrangements to sell their oil at $90 or above. Fedun says those arrangements are due to expire soon, which will lead to an industry crash.

The decision by OPEC shows that rival oil-producing nations aren’t fazed by new competition from the U.S. and are willing to wait out a short-term plunge in oil prices.

“There’s a price decline. That does not mean that we should really rush and do something,” OPEC secretary general Abdallah Salem el-Badri told BBC News. “We don’t want to panic. We want to see the market, how the market behaves, because the decline of the price does not reflect a fundamental change.”

This news seems to be a mixed blessing for environmentalists concerned about the damage caused by hydraulic fracturing, with OPEC as an unlikely ally. Roughly a third of U.S. fracking operations would be too cost prohibitive to continue, say economists. Further, if oil sands production has dubious prospects, it could possibly put a halt to the Keystone XL pipeline even after congressional Republicans approve it in 2015. 

However, environmentalists also note that when oil prices fall, people and businesses may consume more oil-based energy products like diesel, jet fuel and gasoline. 

"If oil is high, people will burn less; that's a good a thing," Jackie Savitz, vice president for U.S. Oceans at Oceana told NPR. More importantly, Savitz said, is that the U.S. government continue to invest in the transition to renewable energy as such policies could have a real impact on future oil production and energy prices. 

Cliff Weathers is a former senior editor at AlterNet and served as a deputy editor at Consumer Reports. Twitter @cliffweathers.

 

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