Opec tries befriending US shale oil after ignoring it, fighting it

In front of the Petroleum Club of Midland, Texas -- capital of the booming Permian shale region -- an electronic display flashes two crucial pieces of information: the oil price and the number of drilling rigs.

For the past year, both figures have been climbing as OPEC oil production cuts led to higher prices, spurring added drilling activity in the U.S.

But the rise in the latter inevitably threatens the former. With the number of rigs up almost a third over the last year, U.S. production has surged above 10 million barrels a day, surpassing the all-time high set in 1970. That, in turn, puts downward pressure on crude prices, disrupting OPEC’s plans. And a lot more shale oil is coming, both in 2018 and beyond, executives and traders said.

"At current prices, the market is incentivizing US shale companies to produce more," said David Garza, a veteran oil executive who runs the Houston office of energy trading house Gunvor Group Ltd.

The Organization of Petroleum Exporting Countries has been struggling with US shale for almost a decade now. For the first few years, it downplayed the production as a mere blip. Then, in 2014, with the market oversupplied, it decided to fight head-on, opening the spigots and sending oil prices to below $30 a barrel in a war of attrition. After a two-year pump-at-will period, OPEC blinked first and cut production in 2016 in an effort to revive prices.

"Shale oil, I don’t know how we are going to live together," former OPEC Secretary General Abdalla Salem El-Badri told US oilmen in 2016.

After downplaying and then attacking, OPEC has spent the last year making nice with its US shale adversaries, in an effort to understand the magnitude of the problem and perhaps convince the rival producers to show restraint. But despite dinner invitations and behind-closed-doors conversations, shale continues to increase output and grab market share. Rising global oil demand has so far absorbed the extra US  crude barrels, limiting the impact on prices. But for the cartel, shale remains as intractable as in the past.

"OPEC is struggling to understand shale," said Daniel Yergin, the oil historian and vice-chairman of consultant IHS Markit Ltd.

In part, OPEC created its own nemesis. After it flooded the market in 2014, oil prices crashed, forcing shale producers to reshape themselves into fitter, leaner and faster versions that can thrive with oil at $50 a barrel. As oil prices recovered, so did drilling.

A year ago, Mohammad Barkindo, the current OPEC secretary-general, invited his shale rivals for dinner in Houston during the annual CERAWeek industry conference. It was a first-of-its-kind event and both sides exchanged pleasantries. But if anyone expected that shale would help the cartel, it’s now clear that US  oil barons are fine with remaining free riders as OPEC seeks to instill market discipline. Since the salad-and-chicken dinner last March, US  output has risen roughly 1.1 million barrels a day -- the equivalent of OPEC member Libya.

Barkindo plans to meet his shale frenemies again for dinner during CERAWeek, which beings Monday and gathers thousands of oil executives, traders, bankers and investors in Houston. "One of the lessons learned from this oil-price cycle is that as producers we are all in the same boat," he said in an interview.

Others inside OPEC are sounding exasperated as the resurgence in shale output could force the cartel to prolong its output cuts beyond the end of 2018. Suhail Al Mazrouei, the United Arab Emirates oil minister, believes shale producers should show gratitude. "If you are a shale oil producer, who brought you back? It was OPEC," he said at a recent industry conference in London. "Without OPEC there’d be chaos in the market."

In Houston, it’s unlikely shale producers will bow to OPEC. Instead, more discipline may come from pressure brought by company shareholders. Investors, tired of losses, are demanding shale companies focus on returns, rather than just growth. Moreover, the boom is hitting natural limits: drilling costs are rising, pipeline capacity is limited, and workers are more expensive. "Now hiring" signs abound in Midland as the state sees its unemployment rate dip back below the national average.

And yet, with oil trading about $10 higher than the average of 2017 the risk is still of more shale growth, rather than less. If US  government forecasts prove right, the industry will add another million barrels a day of extra oil production this year.

"US  shale production is going to continue growing strongly," said Mike Loya, the Houston head of Vitol Group, the world’s top independent oil