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Takeaway: Oil prices are now down over ~50% from June of last year which has surprised…. Well, pretty much everyone.

"The main purpose of the market is to make fools of as many men as possible."

- Bernard Baruch

Oil Déjà Vu: Market Making Fools of Men (Again and Again) - Oil cartoon 02.05.2015

A quick trip down Memory Lane:


Back in October, people said there was a “price floor” because it was uneconomical for “high cost” U.S. Shale Producers to produce below $80/barrel...


In November, people said there was a price floor because OPEC was going to cut production...


Then in January, people said there was a price floor because oil rigs were being idled at a rapid pace...

The one thing clear now is that the world has learned a thing or two about oil production now that we are in the $50/barrel range:
 

  1. U.S. shale production has become much more efficient and a breakeven cost of production for most is well below $80/barrel.
  2. Physical markets adjust to volatile financial markets on a lag (supply/demand):
    • Many producers hedge out the price of oil which eases some of the pain of shorter-term price movements
    • Producers are often tied into contracts that require them to keep delivering oil
    • Because the money to develop an oil field is spent upfront, many E&Ps will produce an incremental unit of product at an operating loss before cutting production cold turkey

     3.  OPEC’s main focus is to keep market share. Cutting production risks the possibility of end-user customers finding a new producer to source crude oil. Market share is key for keeping “swing producer” status. OPEC has already been consistently losing this share since its “oh-so-powerful” status during the 1970s embargo years when they had a 50%+ share in global markets.

     4. Aggregate production levels can increase even with rigs coming offline at a rapid pace. Oil companies will sideline lower-producing rigs in more mature oil fields and produce more from their best rigs on the most lucrative acreage in tough times of low prices.

Oil Déjà Vu: Market Making Fools of Men (Again and Again) - OPEC Market Share