The oil price war has crushed offshore drilling worldwide, which OPEC is happy about at the moment. Image source: Seadrill.

The drop in oil prices from over $100 per barrel a year ago to as low as $46 per barrel in early 2015 was driven by a number of factors, but one of the most important was OPEC's desire to squash the U.S. fracking market. Saudi Arabia, in particular, has seen the rise of fracking in the United States as a threat to its market share, and as prices have fallen the country has actually increased oil production to a record 10.3 million barrels per day in April.

Now that U.S. producers are shutting down drilling rigs, and some U.S. drillers appear to be in financial trouble, certain OPEC leaders are claiming victory. But we need to consider the bigger picture before accepting that the fight over U.S. shale oil is over.

OPEC's victory lap
The comments that caught everyone's attention last week were the International Energy Agency saying U.S. shale had "buckled" under the pressure of low prices and a Saudi official telling the Financial Times that its moves had "deterred investors away from expensive oil including U.S. shale, deep offshore, and heavy oils."

Neither of those statements are incorrect, but that shouldn't mean OPEC can just allow oil prices to rise to $100 per barrel again and face no competition.

The problem facing oil prices today
While oil has bounced from lows of about $46 per barrel for West Texas Intermediate crude to roughly $60 per barrel this week, some of the fundamental problems related to pricing still haven't been solved. The U.S. is still producing more oil that it can consume and inventory is near record levels.

Source: U.S. Energy Information Administration.

Meanwhile, a "fracklog" of 322,000 barrels per day is waiting to be turned on when oil prices go higher, according to Bloomberg Intelligence.  

Oil production growth might be slowing, but that doesn't mean the U.S. is suddenly in dire need of foreign oil. A longer trend of lower production and growing demand is needed for OPEC to really claim victory, and that could be years away.

There isn't a lot of oil drilling work going on in the U.S. today. Image source: LINN Energy.

Technical moves are real
Trading oil is a strange place because investors aren't actually buying or selling oil, they're buying and selling the right to oil at some date in the future. That's why the recent surge in oil prices might be little more than a temporary bump.  

In March, Reuters reported that hedge funds had begun making record short bets against the price of oil. That technical factor is important because when managers have to buy back their futures contracts as they expire it can create a short squeeze, pushing oil prices higher sharply.  

This isn't a fundamental move, it's a technical move akin to when a stock with a large short interest rises sharply and then a further rally is fueled by short-sellers buying back shares. But unless fundamentals improve the move won't last.

U.S. oil could be back in a heartbeat
The biggest worry for Saudi Arabia is that any upside market share it gains from squeezing shale drillers could be gone in a heartbeat.

Unlike Saudi Arabia, the U.S. is a capitalistic oil market, so if oil prices rise above the threshold at which drillers can make money they'll turn the spigots on again. In some locations, that will be $60 per barrel, in others $80 per barrel, but no matter how you look at it supply will increase if prices rise, limiting OPEC's upside.

The old rock and hard place
What's clear is that OPEC has found the breaking point for U.S. shale oil somewhere between $50 and $100 per barrel. As prices go lower on that spectrum the cartel can take a larger role in the oil market and potentially even spur oil demand growth, something that has waned in recent years.

But there's a downside. Shale drillers have proven that they'll put billions of dollars into new production as oil prices creep higher toward $100 per barrel. That limits OPEC's upside in the oil market and could mean many more years of low prices before it can really put the nail in the coffin of shale oil's weakest players. Because if prices go up too fast, as they are right now, shale production will pick up rapidly.

OPEC might be happy with the decline in U.S. drilling today and may be satisfied with the bounce in oil prices in the last month, but the upside is still limited given the dynamic nature of U.S. oil drillers. This war is far from over, and right now calling a winner is like calling a winner in a bloody heavyweight fight with both fighters left standing. The crowd (the economy in this case) is a winner but the fighters haven't gained much from the punches they've thrown and may be worse off at the end of the day.