Market disruptions are common when new ideas come along; and participants have problems pricing because there are few precedents. Dot.com was an example, so were the derivatives that led to the financial meltdown in 2008.
There are signs shale oil might turn out to have been a similar story, currently unfolding. What is not commonly understood is because legacy losses are so high, a 10% increase in new production gives a 60% increase in the total shipments, that explains the 2.4 million barrels per day increase in total shale oil shipments over the past two years; that's more oil than OPEC took off the table. But a 10% drop in new production delivers a 60% drop in shipments.
Last week on Bloomberg News, Javier Blas wrote of a new “Shale Boom” (that could create) “OPEC’s Worst Nightmare”. That pretty-much sums up the consensus. Two main points: first the year-on-year change of U.S. production of “oil, condensate, and natural gas liquids”; was up by 3.0 million barrels per day per year in August 2018, that’s a 35% increase year-on-year. Second; although now the pipelines serving Permian are maxed-out, new pipelines will start to flow by the end of 2019.
I disagree with the conclusion. I believe that the shale-war waged in 2015 and 2016, when OPEC drove prices down to under $30-Brent; has backfired; first because that killed conventional exploration and production, second because the idle production capacity, selling for pennies; dramatically lowered the cost of going after shale-oil, which re-booted that industry. But now costs are going back up, shale legacy loss is heading for 600,000 barrels per day per month, and initial production per completion flat-lined since 2017.
According to the latest report by The International Energy Agency (I.E.A.), if U.S. shale oil does not increase production by 1.6 million barrels per day per year, next year, and the year after, and the year after and Amen, there will be a “supply-shock”. The CEO of Schlumberger has a similar view.
Looks like that could be happening now
Over the past five months the trend in new-shale oil went from 150,000 barrels per day per month (i.e. average 1.8 million barrels per day per year), to 100,000 (i.e. 1.2 million barrels per day per year); the trend-line is pointing at zero by mid 2019. I believe there is a real risk that the war that OPEC denies they were waging; could have created the World’s Worst Nightmare, with OPEC and Russia as the main beneficiaries.
This is the chart put up by Javier Blas, with shale-oil superimposed:
The spike to 3.0 million in August 2018 was not all about shale; it was mostly due to offshore oil, sanctioned before the bust, coming on line. There is not much more of that in the pipeline. Notice the down-tick in shale-oil after August.
Just no one noticed anything alarming.The reason is that shipments go up-and-down every month, so it's hard to see the trend.
There is a better way to understand the trend, but no one tracks that number. Initial production (I.P.), which is how much oil comes out of a new well, in month-one, is reported by E.I.A. but only as IP-per-rig. To work out IP-per-region you have to multiply rigs (also reported) by IP-per-rig. that tells you how much new oil was brought on the table.
But then there is legacy loss, shale oil wells deplete fast. In October initial production of all the seven shale-regions was 600,000 barrels per day, but legacy loss was 500,000; giving an extra supply (IP-net-legacy) of 100,000.
This is a chart of the more recent history. You won’t find these numbers on the E.I.A. website, but they are all based on what E.I.A. reports, just re-arranged and aggregated:
The black line is the one line in the preceding chart, year-on-year change in production; divided by 12-months for comparison with other monthly estimates. The blue line is total initial production (I.P.) less legacy-loss; calculated by multiplying reported IP-per-rig in each region by numbers of rigs, adding that up and then subtracting total legacy loss. That’s a measure of the capacity, and the enthusiasm of operators to drill.
The brown line, monthly change in production (i.e. shipments) is derived by simply taking this month’s total production, from last month’s, that’s a raggedy line because of logistics, but if you add those numbers up over time they come to the same as IP-Net-Legacy, so that checks.
Of course the down-trend could be a blip, eyeballing trends is a mug’s game; but there is no escaping that right now the trend is not up, it’s down.
If shale doesn’t deliver what almost everyone is projecting, and conventional E&P, which is still in the doldrums, cannot deliver enough to plug that gap, which is what the CEO of Schlumberger recently warned might happen, the price of oil could spike.
Everyone was watching in awe as shale-oil delivered 2.4 million barrels per day extra; in less than two years, which is more than OPEC (eventually) took off the table; and everyone assumed that would go on up-and-up, forever, like house prices, and like Nassim Taleb’s thanksgiving turkey.
One thing is certain about the oil industry; it’s full of Big Surprises. Not many commentators thought that when Brent was priced over $100 in 2011, that was a bubble that would bust to below $70, not many predicted shale would re-boot and then boom, starting June 2016
Be prepared for Big Surprises, from time to time they sneak-up from out of nowhere.
There are plausible reasons for why the trend in growth-rate of shale-oil production has been going down. Yes indeed, since June the pipelines serving Permian, were maxed-out, new pipelines are being built, once those come on line, operators will likely become more enthusiastic about drilling for oil.
That makes some sort of sense, but there are other ways to transport oil out of Permian, the reason operators prefer pipelines is because they are cheaper by up to $8 a barrel. But year-on-year, up to last month, oil prices went up by 45%, that ought to have covered the increased cost of shipping, if that was really what was holding shale back.
Another story making the rounds is that operators are drilling wells but not completing them, waiting for a good moment to do that, as in when either the oil-price goes up, or the pipelines come on-stream.
That’s credible; day-rates of drilling rigs, are going-up fast; so that could make sense, locking in low-cost before they go up more.
Drilled but Uncompleted wells in Permian went from just 1,000 in 2014 to 4,000; over the past two years; and on average 35% of drilled wells in Permian ended up uncompleted so clearly there could be some truth in that story. But as the CEO of Schlumberger recently remarked, new plays have started to poach from existing ones, so you drill; then you wait for next-door plays to deplete before you pump the sand.
On the other hand, some snide-commentators have suggested that many uncompleted wells are in fact, Dead-On-Arrival’s . You only get to know for sure what is the geology of the hole you drilled, after you drilled it, so a common reason to decide not to pump the sand and buy the pads; which are the expensive parts of the operation; might be that what you got was less than optimal.
This chart can perhaps explain what’s going on:
Yes uncompleted wells in Permian shot up, but that’s not a recent development, it started long-before there was talk of pipelines maxing-out. In early 2016, uncompleted wells in other regions fell, that was completions catching up, but only about 20% of the “inventory” was completed, and Initial Production per completion (shown below), fell by 40%, indicating that those were less than optimal. Perhaps the remaining 80% were Dead-on-Arrival, that will never be completed?
Another indicator worth keeping an eye on; is initial production per completion:
A story that has been making the rounds is the one about how the resurgence of shale-oil was thanks to can-do ingenuity and technology.
The evidence does not support that thesis; but that’s not common knowledge because to see those numbers you need to work out I.P. from E.I.A.’s “Drilling Productivity Report”, then you need to get the other report they put out, confusingly called the “Drilled but Uncompleted Report”, which enigmatically contains information on completions, which is not something you might have guessed from the title. No wonder there is confusion about what’s going up and what’s going down.
Yes indeed, Initial Production per Completion went up dramatically in Permian after oil prices tanked, but only until two years ago. That marker went down in Eagle Ford, during the time 20% of the “rainy-day” uncompleted wells were completed, then when they got back into gear, drilling + completing, that spiked, but the trend now, is down, not up.
Perhaps the “magic” was nothing to do with technology, after all hydraulic-fracturing has been around for years, long before anyone thought of using it for shale? In 2016 hardly-used drilling rigs; and power-packs to pump the sand, and anything linked to oil could be bought from liquidators for pennies, I know, I was shopping…cash-sales only! Also the cost of sand went from $87/ton to $25; and there is a straight-line correlation between how much sand you pump, and initial production (within limits). So everyone started drilling longer laterals, so they could pump more cheap sand.
But today sand costs $75/ton; yes more mines are coming on-line, but the big cost is the last mile; CAT jacked prices on the power-packs, steel for the casing and the pads costs double what it was in 2016, oil-service companies are starting to pick up business offshore, so their prices went up, and the best drillers and geologists are trading views of Permian farm-land, for all-round sea-views and layovers in Phuket.
Here’s a thought, perhaps the reason why, since the re-boot in September 2016, shale oil production went up by 2.4 million barrels per day, which is much more than OPEC took off the table, was simply that costs went down. If so, now that costs have gone up, and are set to go up more, logically that should mean new-production is set to go...down, not up?
This is a plot of total initial production, net-legacy; against the six-month trailing oil price.
The X-axis is the six-month trailing average of West Texas Intermediate, which is kind-of a proxy for time, over that period, at least up to a month ago. The idea for using that is because shale-drillers look at where the price seems to be going, decide how much to hedge, then go for it. Shale is many short-term plays, if you don’t make your money-back on a play in eighteen months, well; you need to put on your best suit, polish your cowboy boots, and go find another sucker on Wall Street.
Trend #1: Low oil price, OPEC thought they had shale on the run, if they kept pumping shale would die. Except E&P worldwide ground to a halt, costs went towards zero; and pesky shale came back, with a vengeance.
Trend #2: Yes oil prices were up, but costs went up faster, the line flattened-off.
Trend #3: That’s logical...to a Black Swan; oil prices going up and shale Initial Production net Legacy goes down.
Last but not least, is the trend in legacy-loss (red-line), right now shale needs to find 500,000 barrels per day new oil every month, just so as to stay-even; that number is going up; when it equals I.P.; that’s Peak-Shale, in other words, that’s the end of the road.
Intriguingly, when OPEC cut back, oil prices went up, and that hastened the demise of shale, because costs went up more than prices. That’s a negative feedback loop, (1) oil price goes up; (2) everyone starts to drill, (3) cost of drilling goes up so no-one makes any money; (4) everyone stops drilling, (5) price of oil goes up...round and round.
The reason oil prices crashed to under $30 Brent, not $64, which is where the few commentators who predicted the bust, more than two years in advance, said it would go; was because for two years OPEC, uncharacteristically, decided to pump more, not less.
They deny that was a strategy to kill-off shale oil. In any case if that was the strategy it didn’t work, because the whole of the oil industry all over the world imploded; so anyone with any sense could buy bank-owned equipment for pennies.
Then, because costs were through the floor, shale boomed. Thank you very much Mr.OPEC.
The best-thing for OPEC & Co. would be to forget about starving shale to death, cut production, and then wait, for a year or so, for shale oil to peak. That’s what they decided to do on 8th December; smart move.
Whether or not that will leave enough time for conventional E&P to plug the gap, is anyone’s guess.
This is a photo of mobile offshore drilling rigs in Hamriyah Port in U.A.E., those have been stacked for two years. Until Brent settles above $75, they won’t be going anywhere. Same story in ASRY in Bahrain except more.
Those are all cold-stacked, no-one on board, generators off, no shore power; certificates all going out of date, hydraulics clogging up, marine-growth in the seawater lines, likely there will also be steel to fix in the splash-zone. Tough to get all that sorted in less than six months. Then it normally takes three-to-five years from when the unit goes to work, until oil starts to flow somewhere.
Don’t be surprised if peak-shale comes in 2019, and if that happens, don’t be surprised if the supply-crunch the I.E.A. warned of, comes sooner than anyone was expecting.
In 2011 one model that relies only on the value of oil, said that $120 Brent was a bubble and so, at some point the oil price would plunge to $64. That same model is now saying that the bust lasted much too long, artificially prolonged by OPEC’s decision not to swing in 2015/16, and that next there will be a reverse bubble, to $150 Brent or more.
So two reasons to suspect that shale oil might not deliver enough new oil to avoid the supply-crunch that I.E.A. and Schlumberger are talking about.
If that happens, this time there won’t be easy-money around so that consumers can borrow to pay for oil they can’t afford, like they could last time. In that case the demand-destruction could trigger a global recession.
Disclosure: I am/we are long OIL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.