Credit Suisse: The Oil Price Wars Have Begun

The fact that Saudi Arabia produces nearly 10 million barrels of oil a day is not the only reason it’s been called “the central bank of oil.” The desert kingdom has earned that designation by using that massive output to have a singular influence on the oil market for decades. Most recently, it has used its heavy hand to help keep the average annual price of Brent crude hugging $110 for each of the past three years. With oil prices plummeting of late, then, it was reasonable to assume that Saudi Arabia would respond to the rout by encouraging its fellow members of OPEC to slash production at their meeting late last month.

That didn’t happen. OPEC’s decision to keep its production target unchanged sent oil prices even lower, and Brent hit a five-year low of $66.84 per barrel. But the long-term implications of the decision may be far more significant than the short-term ones. U.S. shale producers will play a particularly important role in setting prices, Stuart says, because their output is growing fast—so much so that they helped the U.S. overtake Saudi Arabia as the world’s largest oil producer this year.

The U.S. shale companies will surely be reluctant to put new projects on hold or cut production right away, especially since many are used to the boom times and have promised shareholders rapid growth. But eventually they’ll have to: Credit Suisse estimates that the price of WTI needs to be about $75 per barrel for the industry to keep funding its growth shale fields. But supplies cannot fall all that fast. Industry inertia means that all else equal, the need to build inventory in the first quarter will most likely keep WTI prices at an average of $62 a barrel in the first quarter, according to Credit Suisse.

If WTI averages $70 per barrel in 2015, cash flow for shale producers will fall by 20 percent next year and capital expenditures will drop 18 percent, according to Credit Suisse. The likely result, according to Stuart, is that shale production will only grow by 400,000 barrels a day next year, compared to a forecasted increase of 1.1 million barrels this year.

All that said, the end of U.S. shale is not nigh. Sustained lower prices will surely force the industry onto a slower growth path. New drilling projects will be put on hold and there will be layoffs. But those companies with strong balance sheets should be able to withstand the impending pressure, and some that need it may still have access to debt markets.