T. Boone Pickens' Ideas on OPEC Are Dangerous to U.S. Energy Companies

T Boone Pickens' concerns about OPEC are valid, but cutting them off would do more harm than good. Source: Steve Jurvetson via Wikipedia

"I am not too keen on exporting when we are importing 9 to 10 million barrels a day ... When you are buying from OPEC, some of that money gets in the hands of the Taliban and Al-Qaeda."

-- T. Boone Pickens, from World LNG Fuels 2014 Conference

In a vacuum, cutting off OPEC seems like an easy step to take, especially with North American oil output set to grow over the next several years and consumption declining. But the risk of such a move would likely cause much more harm than good in both the short and long term. After all, oil pricing is global, and OPEC can beat us on price. 

Pushing OPEC's more rogue nations could result in the market getting flooded with oil, driving prices down and burying domestic producers like Ultra Petroleum  (NYSE: UPL  ) and Continental Resources  (NYSE: CLR  )  Clean Energy Fuels (NASDAQ: CLNE  ) which Pickens co-founded, itself depends on oil being expensive relative to natural gas, so oil collapsing would be devastating to his own net worth.

How bad could the damage be? Let's take a look.

Domestic oil is viable partly because OPEC lets it be
Oil and gas production costs have come down significantly over the past few years in shale formations like the Bakken in Montana and North Dakota, and the Eagle Ford in Texas. Continental Resources has been one of the innovators, finding ways to get more oil out of stubborn, deep rock, for less money. From the company's 2012 annual report, its average production expense cost per barrel of oil equivalent (boe) has declined 35% since 2008, while the price of oil has skyrocketed. 

But while the direct production expense has gone down on a per-barrel basis, all of its other costs have gone up as the company's production has increased, meaning the total production costs per boe has actually gone up 22%, from $28.49 in 2008, to $34.77 in 2012.

Continental CEO Harold Hamm is no OPEC fan, but wants a global market for his company's oil. Source: David Shankbone via Wikipedia

Before you say, "Hold on! $34.77 is pretty cheap!" remember a couple of things: Continental (and Ultra) are E&P companies, and the costs above only cover production. If the company doesn't find new resources, its business literally dries up. These companies invest heavily in exploration.

Second, shale wells typically produce strongly for a year or two before production falls off by as much as 80% and stabilizes at this lower level. The result is producers like Continental and Ultra Petroleum must constantly explore for new formations just to maintain production levels. 

While Ultra Petroleum (primarily a natural gas producer despite the name) doesn't give the same detailed breakdown of oil production costs in its annual reports as Continental, the company's recent significant acquisition in the Uinta Basin gave us a little insight into its costs for oil production. CEO Michael Watford said that this acquisition offered "exceptional returns at oil prices well below $75." in the press release. Oil prices would have to fall significantly from current levels to harm Ultra Petroleum -- at least in the Uinta Basin. 

Since this was part of a strategy to diversify into more oil to avoid exposure to another collapse in the price of natural gas -- which fell below $2 per Mcf at one point in 2012 -- the risk with Ultra's production in the Uinta Basin would be if OPEC did indeed flood the market and drive prices down. The move to diversify could backfire. 

Clean Energy Fuels could take the largest blow
The secret to Clean Energy Fuels' future is oil prices remaining relatively high in relation to natural gas. The largest natural gas fuel supplier for transportation in North America is betting big that diesel will remain expensive, and natural gas will remain cheap. However, record cold weather has pushed up the price this winter, and in 2015 there will be further price pressure as exporters like Cheniere Energy begin shipping liquefied natural gas to overseas markets. 

There is still a significant discount today ($4.29/Mcf natural gas translates to $0.61 per gallon-equivalent), but if natural gas keeps rising and diesel falling, Clean Energy's margins would get squeezed at best. In a worst case scenario where OPEC drowns the market, truck buyers could get skittish and stick with diesel trucks, leaving Clean Energy with dozens of LNG stations, and not enough customers. 

Final thoughts
It's unlikely that the worst-case scenario happens. At the end of the day it's a zero-sum game to worry about how much crude oil we import and export. The U.S. is a net exporter of oil products for the first time in more than a decade, and production is expected to keep rising even as domestic demand contracts.

Opening new markets to crude, while continuing to buy some from OPEC, helps the market retain stability that could get disrupted if we followed Pickens' ideas. The OPEC states -- even the rogues that aid terrorist groups -- will have a market for their product, and unilateral action by the U.S. would lead to much more damage than good, both economically and politically, with only downside for U.S. energy companies, their employees, and investors -- like Pickens.

American energy policy isn't the only threat to OPEC
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