If OPEC cuts production, U.S. drillers could march rigs back to oil patch

Energy companies in Houston, Texas and across the country will look east this week as OPEC nations attempt to conclude a truce in an oil-market war that has cost 150,000 American jobs and buffeted the local and state economies for the better part of two years.

The outcome of OPEC's talks in Vienna on cutting production may well determine whether crude prices and the industry's nascent recovery continue their slow climb out of the worst oil bust in 30 years or plunge again, leading to more layoffs, spending reductions and bankruptcies. The formal meeting of the Organization of the Petroleum Exporting Countries follows more than a week of on-again, off-again deals between cartel members other major oil producers that has left global markets gyrating, rising on reports of imminent agreement and falling on news of dissension.

"Everybody is hopeful," said Mark Franki, an engineer at San Antonio driller Metano Energy. "But they rarely agree on anything. It sounds good - hope they do it - but we're not going to hold our breath."

OPEC, which controls about a third of the world's oil supply, set the stage for the high-stakes meeting just over two months ago in Algeria, where member nations reached a preliminary agreement to cut output by up to 750,000 barrels a day. Recent reports out of Vienna, where the deal would be finalized, suggest that some nations have pushed to double the production cut to 1.5 million barrels a day, although Iran, which is ramping up production after years of international sanctions, is resisting.

U.S. crude prices on Friday dropped 4 percent to $46.06 a barrel amid reports OPEC canceled a Monday meeting with non-OPEC producers, including Russia, as internal disputes over the deal remained unresolved.

Prices hang in balance

Some analysts forecast that an OPEC production cut could send crude prices toward $60 a barrel, an increase that could return many shale drillers to profitability and spur drilling, spending and hiring in the oil patch. But analysts have also warned prices could fall below $40 a barrel if the talks come up short, a development that could reverse the recent burst of activity in North American shale fields.

"Their confidence would be shaken," said Andy Lipow, an oil market analyst at Lipow Oil Associates in Houston. "We still have a number of producers under financial stress, and if the deal falls through, it won't get better in 2017. Their merry Christmas isn't going to be so merry."

That OPEC is even considering a cut represents a major concession by the cartel and its most influential member, Saudi Arabia, which two years earlier, chose not to intervene in the market as U.S. oil prices slid from a peak of $107 a barrel in June 2014. By early 2016, prices had plunged to a low of $26 a barrel, decimating scores of high-cost U.S. shale producers, lowering U.S. output and setting the stage for prices to rise again.

Saudi Arabia, it appeared, was abandoning direct intervention into oil markets, opting to let the laws of supply and demand to do the dirty work.

"The tools that OPEC has used in the past - targeting specific prices - have not always worked in the long term," Saudi energy minister Khalid Al-Falih said in an interview with the Houston Chronicle in June. "No matter what we do, ultimately markets win."

But the oil bust lasted longer - and U.S. shale drillers proved more resilient - than expected as Saudi Arabia faced financial pressures too sharp to ignore. The kingdom over the past two years burned through $180 billion in financial reserves, about a quarter of its coffers, to maintain government spending as oil revenues plunged.

Saudi Arabia pumps oil cheaply, but it still needs $92-a-barrel oil to balance its budget and maintain the generous social spending that has helped Saudi Arabia avoid the unrest in other Arab nations. Its budget deficit is equivalent to 20 percent the nation's economic output, about twice the size of U.S. deficit in 2009, the worst year of the so-called Great Recession, according to energy research firm Wood Mackenzie.

Large deficits

The ruling House of Saud's support is one reason analysts believe OPEC has a better chance of reaching an agreement than it did in April, when Saudi Arabia scuttled a similar deal amid tension over Iran's emerging oil industry. Iraq, Kuwait and the United Arab Emirates also face large deficits and declining oil revenues because of stubbornly low oil prices.

Iran, though, relies far less on oil than its rivals to fund its budget, and OPEC may have to sweeten its terms for the country, which in January began pumping more oil after western powers lifted economic sanctions. The Islamic Republic has maintained for months that it has a right to bring its oil production back up to 4 million barrels a day, the amount it produced before western powers issued economic sanctions against it in 2012.

It told OPEC recently that its output stood at 3.92 million last month, a development that may make Iran more willing to commit to cap production at current levels.

OPEC's bid to retake control of oil prices this week also will test whether it sill has the clout to affect prices in a global market that has changed dramatically since the cartel abandoned its price-setting role in November 2014. In fact, it may be too late for OPEC to fully recapture the attention of an oil market, which in the past hung on the cartel's pronouncements.

Today, a host of indicators outside OPEC's control can move markets, including the value of the dollar, the number of active U.S. drilling rigs, and the amount of commercial oil stored across the United States.

"The last two years have trained the market to look at other signals," said Ann-Louise Hittle, an oil market analyst at Wood Mackenzie.

Years ago, oil traders had far less information about how much oil was flowing around the world. But the market has become more transparent with the advent of technology such as lightweight sensors that track volumes moving through pipelines and coming out of oil fields, making it far more difficult for small numbers of market players, over a long period, to set prices by manipulating production levels.

"Since Rockefeller, we've had a single market balancer," said Jamie Webster, a fellow at Columbia University's Center on Global Energy Policy, referring to John D. Rockefeller's Standard Oil trust that dominated the industry in the late 19th century. "Now you're looking at several that have some measure of control. It's not just that OPEC is going to cut and the oil market is going to respond."

'Great theater'

For example, if OPEC's planned cuts in production elevate prices, that could further increase the count of active U.S oil rigs - another important measure in today's market. Eventually, an increase in U.S. drilling could lift domestic production higher, offsetting OPEC's reductions and again exerting downward pressures on prices.

"At some point down the line in 2017, you'd see an increase, if not a surge, by U.S. shale producers, which takes us back to the situation we're in today," said Neil Atkinson, head of the oil markets division at the International Energy Agency. "We didn't fully appreciate how resilient they'd turn out to be."

Others contend that even if OPEC agrees to cut production, the long history of cheating among cartel members could complicate its efforts. OPEC producers exceeded the cartel's 30 million-barrel-a-day target for all but nine months of the four years the target was in effect from 2011 to 2015, according to a review of OPEC data.

"It is great theater," said Jeff Colgan, a Brown University professor who studies the geopolitics of energy. "Politically, it's great to keep the illusion alive that OPEC runs the oil market. But OPEC doesn't do what people think it does."