(MENAFN- Khaleej Times) Are we witnessing the beginning of a new oil world order? Saudi Arabia engineered a short covering rally and cyclical bottom in Brent crude with its May 15 agreement with Russia to roll over last November's oil output cuts for another nine months. The kingdom has, in essence, resumed its traditional role as the "swing producer" of the Opec, a role that former energy minister Ali Al Naimi had abandoned in November 2014 in a quest to protect downstream market share in Asia from Iraq and Iran.
This strategy failed after Brent crude plunged from $115 in the summer of 2014 to $28 in February 2016 even as the US Dollar Index rallied by 28 per cent. The kingdom changed its strategy under the leadership of Khalid Al Falih and Prince Abdulaziz bin Salman at the Opec ministerial meeting in November 2016.
Saudi Arabia engineered a 1.2 million a bpd Opec output cut and cooperated with Russia, Mexico, Oman and Azerbaijan to arrange another 600,000 barrels in non-Opec cuts. This shift in Saudi strategy and intentions was enough to push Brent crude higher to $54 a barrel.
So it was a nasty surprise for the oil markets after speculators in black gold futures caused a 11 per cent fall in both West Texas and Brent crude in late April and May 2017. The oil markets were spooked by bloated global inventories, rumours of Russian and Iraqi non-compliance, a surge in the US land rig count and shale oil output and a 30 per cent fall in Dalian iron ore, a proxy for Chinese industrial growth. This was the context for the May 15 Saudi-Russian extension announcement.
The harsh reality of the world oil market is that US shale oil producers have added 900,000 barrels per day to their output since October 2016 alone. Even though compliance from Saudi Arabia, the UAE, Kuwait and Qatar on the November output cuts has been well over 90 per cent, the surge in US shale oil output has largely offset the Opec output cuts. This meteoric rise of hydraulic fracking technologies and electric vehicles/robotics has gutted the global influence of the Opec as the world oil market's supplier of the last resort (Opec) no longer controls the price of oil since the world's next swing producer is the Permian Basin in Texas and the Bakken in North Dakota, the new kingdoms of shale. Term premia in the long-dated forward West Texas futures markets and implied option volatility have both collapsed since last November's Opec output cut pact, prima facie evidence that the smart money expects far lower prices for crude oil in the next five years.
The US land oil rig count bottomed in June 2016 and has almost doubled in the past year. It is entirely possible that the US shale oil output could rise by 600,000-800,000 a barrel a year for the proximate future. Ominously for oil prices, the increase in the US rig count has begun to accelerate. In the last four months alone, the Baker Hughes land rig count has added 175 operating rigs. This means at least 500,000 of extra US shale oil is guaranteed to hit the oil market in the autumn and winter of 2017.
My analysis of West Texas long-dated futures strip curves, oil option implied volatility and risk reversal skews and wet-barrel premia tells me that even if Saudi Arabia and Russia "stabilise" oil prices after the Opec conclave in Vienna, we could easily see another oil price crash this autumn as US shale oil output floods a glutted market now.
While integrated oil supermajors such as Chevron, Total and Occidental Petroleum offer four to 5.3 per cent dividend yields, I am worried that their ambitions to dramatically increase their US shale oil acreage to preserve their dividend payouts and recoup their cost of capital means US output will surge whenever West Texas rise to $50. After all, this is exactly what happened since June 2016. No rally in the oil market is thus really sustainable since the 4,000-odd US and Canadian shale oil exploration and production companies are financed by Wall Street high-yield debt issuance and syndicated bank debt are forced to increase output even if global oil prices temporarily fall below their marginal cost of production. A paradigm shift has transformed the world oil market in the past decade. Yet make no mistake. The Age of Shale means long-term oil prices could well be as low as $20 a barrel as Texas, not Saudi Arabia or Russia, is the planet's new "swing producer" of black gold.
The writer is a global equities strategist and fund manager. He can be contacted at
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