A new report from the International Energy Administration (IEA) forecasts that oil production in the United States is on pace to overtake Russian and Saudi Arabian oil production as soon as 2019. As U.S. production surpasses that of other major countries, we will see more and more talk—reminiscent of the claims in 2014 and 2015—that the American shale oil industry has become the new “swing producer” of the oil market. I had this discussion recently. These claims are and will be wrong; American shale cannot constitute a swing producer.
The idea behind a swing producer is that one particular supplier (or a group of suppliers working together) can have enough control over changes in supply that it can increase or decrease the price of oil on its own. A swing producer can set the price of oil by either:
- Decreasing its own production to raise prices at a time when other producers have no spare capacity to make up for the global supply loss, or
- Increasing its own production to lower prices at a time when other producers cannot afford or will not choose to decrease theirs to balance the supply market.
In theory, a swing producer can respond to price fluctuations by increasing or decreasing production to keep prices relatively stable.
In the 1970s, OPEC was often a swing producer in the oil market, cutting production and embargoing global supply to raise oil prices at a time when other producers had no spare capacity. This strategy resulted in great profits and newfound market controls for OPEC countries.
In the 1980s, Saudi Arabia attempted to act as a swing producer alone within OPEC. Saudi Arabia agreed to cut its oil production on behalf of OPEC to keep prices from falling. However, at that time Saudi Arabia was not the only producer with spare capacity. New oil production from Alaska’s North Slope and Britain’s North Sea meant that as Saudi Arabia decreased its own production to keep prices from dropping, oil from elsewhere poured into the market, made up for missing Saudi supply, and pushed prices down. Saudi Arabia failed to be a swing producer in the 1980s.
The U.S. shale industry of today is not, and can never be, a legitimate swing producer in the oil market. Here’s why:
1. The combined power of the shale industry is probably not great enough. In 2014, at the height of the shale revolution and when the shale oil industry was first called a swing producer, the five largest shale companies (EOG Resources (NYSE:EOG), Anadarko Petroleum (NYSE:APC), Apache Corporation (NYSE:APA), Chesapeake Energy (NYSE:CHK) and Continental Resources (NYSE:CLR)) were only responsible for 10% of all US crude oil production. Only the most optimist projections of shale growth would indicate a potential for such power within the shale industry in the future.
2. Shale cannot unilaterally raise the price of oil, because other producers have plenty of spare capacity. Nor can shale unilaterally lower the price of oil, because it lacks enough spare capacity and other producers have the financial means to decrease their own production, if desired. If shale producers were to act together and decrease production to raise the global price of oil, the void could be filled quickly by OPEC, Russia, Kazakhstan, or Brazil—all of which have the spare capacity to increase production and likely would if the prices rose and there was room for more oil on the market. If shale wished to swing the price of oil down by producing more, it would face problems because it likely lacks much spare capacity now—most ideas of spare shale capacity are projections for the future—and because countries like Saudi Arabia might choose to decrease their own production and wait out the shale overproduction. In fact, some might argue that shale is overproducing today, and OPEC—along with its partners such as Russia—is cutting its own production to keep prices stable.
3. Shale oil producers in the United States are actually legally prohibited from colluding to set production quotas or impact prices. This is the ultimate reason that shale cannot become a swing producer. However, some argue that shale can act as a swing producer when many independent shale companies take the same actions in response to market conditions. For instance, the price of oil has risen over the last two years and now shale companies are producing more oil again. That is true, but it is not sufficient to make shale a swing producer. There is no strategy behind this, and the self-preservation of each company will keep them from making the difficult decisions to become a swing producer. As another example, without colluding shale producers will never jointly decide to cut production in unison to prop up prices. Each shale producer is out for himself, not for the shale industry or the U.S. energy industry. Without collusion of the type seen in the OPEC cartel, no group of producers can become a reliable swing producer.