As made obvious in the recent election, one of the Trump Administration’s key points is the desire to reduce oil prices for consumers, primarily by increasing U.S. production levels. However, the incoming administration’s goal may be realized not through increased U.S. production but at the hands of OPEC+.

OPEC+ Production Cuts

Oil prices could see a drastic fall in the event that oil alliance OPEC+ unwinds its existing output cuts. According to CNBC,

“There is more fear about 2025’s oil prices than there has been since years — any year I can remember, since the Arab Spring,” said Tom Kloza, global head of energy analysis at OPIS, an oil price reporting agency. “You could get down to $30 or $40 a barrel if OPEC unwound and didn’t have any kind of real agreement to rein in production. They’ve seen their market share really dwindle through the years,” Kloza added.¹

While lower oil prices would be considered to be a positive for most consumers, a significant reduction in oil prices from increased OPEC+ supply could create significant headwinds for Trump’s “Drill Baby Drill” initiatives to increase U.S. oil production.

Given that oil is currently trading about $70 per barrel, a reduction to $40 per barrel would mean around a 40% lower crude prices. The two key adjustments required for the U.S. to increase its production from new wells would need to come from the following two areas: drilling and completion costs for new wells, and operating costs of those same wells once producing.

Drilling and Completion Costs for New Wells

Drilling and completion costs vary depending on the type of well (vertical or horizonal). For vertical wells, the depth of the well is typically the key factor. In the case of horizontal wells, the length of the laterals and cost of fracking and completing the wells will affect the ultimate costs. In the Permian basin, for example, according to a recent article, currently wells in this area are costing between $10-$12 million dollars (depending on the length of each lateral drilled), and they usually take a couple of weeks to drill.² Given a lower oil price environment, these high initial costs may make future wells “uneconomic,” meaning the future cash flows expected to be produced will not result in a high enough level of cash flows to offset the significant upfront costs to drill and complete a new well.

Operating Costs

Operating costs for E&P companies typically refer to:

• Lease operating expenses
• Production and ad valorem taxes
• Gathering, processing, and transportation
• General and administrative expenses
• Other operating expenses

To illustrate the impact of 40% lower oil prices on the financial results for E&P companies, I present a year to date summary covering the first three quarters of 2024 for Diamondback Energy, traded on Nasdaq as FANG.³ Two columns are presented below, one for as reported (actuals) and the second to show the impact of a 40% reduction in oil prices for a successful company like Diamondback, assuming costs did not decrease with oil prices.

As shown, a 40% reduction in oil prices could eliminate 90% of the pro forma operating income of Diamondback, assuming operating costs stayed constant if oil prices were to fall. It is doubtful this would happen, as historically industry participants have been able to right-size operating costs in lower price environments, if given enough time.

Looking ahead, OPEC+’s decisions could create significant headwinds to the goal of increased U.S. oil production and a return to U.S. energy independence, but they would also provide an optimal price environment to begin refilling the Strategic Petroleum Reserve.

WTI Strip Prices Decrease

Spot prices and futures prices for the West Texas Intermediate (WTI) contract decreased approximately $1.00 per barrel in the near term and decreased approximately $0.75 over the longer term.

WTI Strip Prices - One Month Change

As shown, the oil price curve remains in a state of “backwardation,” reflecting the market’s expectation of lower future spot prices.

Oil Price Outlook

The price distribution below shows the crude oil spot price on December 4, 2024, as well as the predicted crude oil prices based on options and futures markets. Light blue lines are within one standard deviation (σ) of the mean, and dark blue lines are within two standard deviations.

WTI Crude Oil $/BBL

Based on these current prices, the markets indicate there is a 68% chance oil prices will range from $58.00 and $81.50 per barrel in mid-March 2025. Likewise, there is roughly a 95% chance that prices will be between $42.50 and $111.00. By mid-May 2025, the one-standard deviation (1σ) price range is $55.50 to $85.00 per barrel, and the two-standard deviation (2σ) range is $37.50 to $125.00 per barrel. This pricing distribution implies that futures market pricing does not yet reflect a decline in oil prices to the $40 per barrel level. In fact, it would be an approximate two standard deviation downward move in oil prices were this to occur within the next 6 months.

Key Takeaways

Remember that option prices and models reflect expected probabilities, not certain outcomes, but that does not make them any less useful. Throughout most of 2023 and 2024, crude oil spot prices have primarily fluctuated within the range of $70 to $90 per barrel. During that time, we observed general increases in futures price volatilities as prices neared the upper bound of that range, as evidenced by the futures price ranges observed. For mid-May 2025 pricing as of December 4, 2024, the 1σ range had a spread of $29.50 per barrel, and the 2σ range had a spread of $87.50 per barrel. For comparison, in 2022 we observed 1σ and 2σ price ranges in excess of $65.00 and $150.00, respectively.

1. "Oil could plunge to $40 in 2025 if OPEC unwinds voluntary production cuts, analysts say," Lee Ying Shan, CNBC, November 12, 2024.
2. "Oil drilling ramps up in Permian Basin," Bob Campbell, Odessa American Online, October 25, 2024.
3. Form 10-Q for Diamondback Energy, Inc.