From The Wall Street Journal

Two sets of oil producers are fighting for dominance: the growing U.S. shale patch and the Organization of the Petroleum Exporting Countries. Investors are trying to figure out which side has the stronger hand.

Oil prices are near 2019 highs, which could give the impression that OPEC, with its production cuts, is the current dominant force. But output from U.S. shale oil producers has doubled from its level five years ago, and more supply coming later in the year could flood markets yet again.

Gordon Gray, head of oil and gas research at HSBC , calls the OPEC vs. American producers a “tug of war.”

OPEC’s aim is to prevent inventory buildup and keep prices at a higher level to balance its members’ government budgets. OPEC and its allies, including Russia, agreed to cut output by a collective 1.2 million barrels a day for six months starting in January, helping prices to rise by a third this year to above $70 a barrel. It isn’t clear whether the group will agree to extend the deal at their next meeting in June.

But don’t count shale out. With three new U.S. pipelines set to open this year that will connect oil wells with the Gulf Coast coast, U.S. oil shipments should surge in the second half of the year. Shale taps can be turned on and off faster than other producers, which has made it more difficult for OPEC to influence the oil market.

“It’s much more short cycle and responsive to price than the vast majority of global production, and it now represents more than 10% of global supply,” said Mr. Gray.

Volatile Compounds

OPEC and shale, plus a weakening global economic outlook, sparked a volatile stretch for oil prices starting late last year. That volatility has now diminished, as the cartel has shown that, so far, it is sticking to its guns on production cuts, which is helping support higher oil prices. When prices rise, volatility tends to dissipate.

“There’s a certain element of confidence that this rally has further to go,” said Harry Tchilinguirian, global head of commodity markets strategy for BNP Paribas .

Inventories are key in knowing who is winning the battle for oil prices. When they are high, the world is flush with excess oil which depresses prices. Commercial oil stocks in members of the Organization for Economic Cooperation and Development, the biggest industrial economies, are expected to increase by 53 million barrels to 2.915 billion barrels this year, according to the EIA. A bump above the long-term average would be bad for oil prices.

Whether OPEC members hold the line on production cuts will depend greatly on their individual financial circumstances.

For instance, this year Saudi Arabia needs oil prices to average above $73 a barrel to balance its budget, according to the International Monetary Fund. For now, prices remain below this level.

“The U.S. oil price needed for shale oil to be profitable is around $53 a barrel or above,” said Roy Martin, an analyst at consulting firm Wood Mackenzie. According to Barclays , a price of $60 is needed to sustain growth in excess of 0.5 million barrels a day.

“OPEC countries have shown that they have a lower survival rate than U.S. producers at very low prices,” said Olivier Jakob, managing director of consulting firm Petromatrix, referring to the ability of national governments to balance their budgets when oil prices drop.

The EIA expects the U.S. to become a net exporter of energy by 2020, cementing the phenomenal transformation shale has created. The U.S. was briefly, for a week in November, a net exporter of crude and refined fuels for the first time in decades.

“The second wave of the U.S. shale revolution is coming,” said Fatih Birol, executive director of the IEA, at the launch of its Oil 2019 report in March. He added that the U.S. will account for 70% of the total increase in global production capacity over the next five years.

And, concerning for OPEC, U.S. oil output is expected to grow by 1.4 million barrels a day this year, to average 12.4 million barrels a day, according to the EIA.

This surging production may not be sustainable, however, with more than a dozen shale companies announcing spending cuts this year as they grapple with paying more than most other sectors to borrow money. For instance, some small- and medium-size U.S. energy producers who borrow in the high-yield debt market are paying around 7 percentage points above Treasurys, according to ICE BofAML indexes.

At the same time, major oil companies now make up around one-fifth of shale production and have better access to funding than smaller peers, and are working to bring shale costs lower.

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