How OPEC's Strategic Miscalculation Created Its Own Worst Enemy

Recently, Andreas de Vries posted an interesting article on Strategy Management: "Does Strategy Matter in a VUCA World?". The main points in it are:

1. An organization's strategy must be based on an expectation regarding the future, not on the reality of today;
2. While executing strategy organizations must remain aware of their environment, because things might not develop as foreseen;
3. Organizations must remain flexible, because if the future threatens to be different from what was assumed the strategy and the strategic plan must be updated.

Andreas used IBM from the 1970s as an example. At that time IBM's expectation regarding the future was that mainframes would remain the core of the computer industry. As we (now) all know, things developed differently and the Personal Computer become much more important. By the time IBM realized this, its market share had dropped by 50%. I could give another example of organization either not tracking their environments closely enough, or not responding fast enough, and getting into trouble because of that: OPEC

In 2012 I wrote an analysis entitled: “The US unconventional oil revolution: are we at the beginning of a new era for US oil?” My key message back in 2012 was “It could be in the interest of OPEC to already increase its production now and allow oil prices to decline to below $60 to discourage further development of shale oil”. This view was based on lessons from history: higher oil prices allow the industry to go into unexplored areas. In this particular case, the threat (from an OPEC perspective, at least) was that the high prices would allow companies to drill horizontal wells and carryout frac jobs on a massive scale, enabling this part of the industry to learn, grow and mature.

Since OPEC didn't implement this strategy, sustained higher oil prices of over $100/B from February 2011 to July 2014 allowed the US fracking industry to grow rapidly. For example, Bakken shale/tight oil production increased from 0.14 million barrels per day (MMBD) in 2007 to 1.12 MMBD in 2014. Likewise Eagle Ford increased from 0.05 MMBD to 1.46 MMBD and Permian from 0.85 MMBD to 1.64 MMBD. Overall, US total unconventional oil production increased from 1.14 MMBD in 2007 to 4.72 MMBD in 2014, helping the US to reduce its net oil import dependency from 60% in 2005 to below 27% in 2014.

But from OPEC’s perspective, however, that is not the most important consequence of its failure to address the strategic threat that fracking is for her. It could be argued that the US fracking experience from 2011 to 2014 has really taken fracking out of the unconventional oil & gas production category and moved it into conventional production (just as deepwater was once unconventional but is now more or less conventional). The techniques used have now been developed to such an extent that for some of the basins they can be used profitably even at an oil price in the range of $50/B - $60/B. Drilling and fracking thousands of wells between 2011 and 2014 has allowed the oil companies involved to better understand the geology, use less water in the fracturing process and optimize the distance between frac-jobs, to maximize production rates while lowering production cost (Recently, the CEO of ConocoPhillips Ryan Lance said operators were seeing 20%-30% reductions in their well costs compared with 2014 peaks). Consequently, fracking can no longer be defeated by OPEC. Even in today's low price environment the tight reservoirs in the US are not being abandoned. Production is merely being postponed. The number of wells waiting to be hydraulically fractured - known as the fracklog - has tripled in the past year as companies delay work in order to avoid pumping more oil while prices are low. Bloomberg Intelligence analysis shows that drillers in oil and gas fields from Texas to Pennsylvania have yet to turn on the spigots at 4,731 wells they’ve drilled. These wells could easily add 0.32 MMBD to current shale oil production of 4.68 MMBD (in 2014 data).

In other words, OPEC's strategic miscalculation has created its own worst enemy. If OPEC had properly scanned the trends in its environment during the period of 2008 - 2012, such as the trends in technology, economic development and demand, and had based its strategy on the future (2012 - 2022) rather than on the past, it could have (substantially) delayed or even prevented swift advancement of fracking success. Unfortunately for OPEC, it was the content with its situation in 2012 and thereby facilitated the rise of fracking with which, in my view, a new era in oil has begun. Due to fracking, namely, OPEC may have lost the swing producer role that made it powerful and influential in the past. To regain its power OPEC need to formulate another strategy keeping in view of current and future expected challenges not only from unconventional but also from renewables.

Dr Salman Ghouri is Oil & Gas industry advisor.

for full referred article please click the following link:

http://europeanenergyreview.com/site/pagina.php?id=3759