Musings On Shale As We Anticipate The "OPEC Meeting" -- November 28, 2016

Some thoughts:

• at one time I bought into "peak oil"; no longer. We're not going to run out of affordable, accessible oil for at least three more human generations (through my granddaughters); probably four generations
• I have no clue why folks are so 'interested" in gasoline at $5.00/gallon. For me, I love gasoline at $1.50 / gallon (free market-based; supply and demand; not subsidized)
• I don't buy into anthropogenic climate change 
• with regard to global supply of oil, right now it's the Mideast (mostly Saudi Arabia); Russia; and, the US
• there is no such thing as "swing" producer any more; having said that, US producers respond to the market; Saudi Arabia tries to manipulate the market; and, Russia ignores the market

I say all that as a preface to this very interesting article in Forbes: shale wars -- where are oil prices headed as Saudi Arabia lets the big bet play out?

Comments and observations:

First, the Forbes subject line: "oil prices." It's a fool's errand to predict oil prices. And oil prices don't matter. As in everything else, it's not the price that matters, it's the margin that matters. If oil is priced at $200 but it costs $180 to produce, the margin is $20. If oil is priced at $50 and it costs $20 to produce, the margin is $30. Price doesn't matter; margins matter.

Second, Saudi Arabia's "big bet." I suppose one could call it a "big bet." Most now consider it a "trillion-dollar mistake." Saudi Arabia tried this at least once before, back in the 80s, to bankrupt America oil companies by driving the price of oil down below what US operators needed to stay in business. It worked in the 80s. It didn't work this time (at least not so far). 

Now back to the article.

Saudi has lost something like $200 billion since their decision in 2014; this jibes with other writers who have suggested $180 billion. So, $200 billion is a nice round number; easy to remember.

Saudi's sovereign wealth fund was $2 trillion; now it's $200 billion less. I guess.

The writer says we are witnessing a two-part test.

The first question: how much damage low oil prices will have caused America's shale industry?

Okay, let's stop right there. Who cares?

In economics, today is always the first day of the rest of your life and yesterday is a sunk cost.

Oh, I get it. The author is suggesting this: if the US shale industry was hurt badly enough, it won't be able to respond quickly to changes in global supply, and Saudi Arabia will gain market share by default.

I didn't see that because I don't see anything to suggest that US shale operators are incapable of successfully responding.

I guess the author had to fill out two long internet pages because instead of asking/answering the two questions he posited, he digresses into the "history of oil."

Let's skip all that, and get back to the two questions, or as the author says, the "two-part test."

Again, the first "test" / question: can the US shale industry respond to global supply and demand or did Saudi succeed in crippling the US shale industry?

Again, the writer digresses back into the "history of shale oil." We all know that history.

Finally, here it is. The Forbes contributor writes:

The results of the first part of the experiment are now known. Over the 30 months of declining prices the number of shale drilling rigs in operation collapsed nearly four-fold, and about one-third of the companies in the shale business went bankrupt or became seriously financially distress.....

wow, he's going back to history that we already know. What's his opinion?  Can the US shale industry respond to global supply and demand or did Saudi succeed in crippling the US shale industry?

Ah, there it is:

The lesson from the first half of the experiment is thus clear: a price drubbing achieved only modest production declines and did nothing to slow and arguably accelerated the radical technology gains in the cost-effectiveness of shale drilling.

Put another way; the Saudis have seen that the amount of money needed to add more American supply keeps shrinking and is moving monthly closer to the Middle East’s vaunted low-cost advantage.

At the current tech-driven growth rate, output per rig will double every 3.5 years. That kind of progress is normally seen in Silicon Valley. For consumers it’s exciting, but not so much for shale’s competitors.

Finally.

Now "part two of the experiment." Just how quickly will American shale production rise this time? 

The writer says we know the answer. The answer is "fast." The writer says: "it won't take much of a rig count rise to produce world-shaking results.

Wow, the writer and I are on the same page. I agree with him completely.

Given what we know from very recent history it’s reasonable to think that the shale industry today could grow again at least as fast as it did from its inception circa 2005 when shale companies went on to more than double U.S. production in a handful of years.

And that happened using technology that was literally half as good as what exists now, and with operators who then had to learn-on-the-fly to use techniques for which there was no prior experience.

That industrial ecosystem now has fantastically better technology, deep experience, and a pre-built infrastructure. One might pay attention to what shale pioneer Harold Hamm, Continental Resources founder and CEO, said earlier this year about U.S. oil production:

“We’ve doubled it. We can double it again.”

The writer than provides the four key characteristics of shale that differ radically from the traditional oil business and that account for shale's past and future velocity.

You can go to the linked article to "discover" those four key characteristics. Regular readers of the blog already know these four key characteristics.

I just wanted to know whether this writer felt that the US shale industry was up to the challenge.

It is.

And I agree. It's really not a question at all, is it?

Oh, by the way. Did the writer ever get around to answering the initial question: where are oil prices headed? Yes, he did. I agree with him. If anything, he's a bit optimistic.

By the way, let's go back to something said early in the article:

At the current tech-driven growth rate, output per rig will double every 3.5 years. That kind of progress is normally seen in Silicon Valley. 

At one time North Dakota had around 200 active rigs and production was wide open and about one million bbls of oil per day.

Now, North Dakota has had less than 40 active rigs for an extended period of time, with much production "choked back" due to economic reasons (DUCs, etc), and production is still about one million bbls oil per day. Unfettered, North Dakota could get to two million bbls per day "overnight."

Oh, one more thought. I started off with this comment/observation:

It's a fool's errand to predict oil prices. And oil prices don't matter. As in everything else, it's not the price that matters, it's the margin that matters. If oil is priced at $200 but it costs $180 to produce, the margin is $20. If oil is priced at $50 and it costs $20 to produce, the margin is $30. Price doesn't matter; margins matter. 

It looks like things might be working out just right: a) prices might rise; b) costs to produce are definitely coming down. Result: better margins. Regardless of the price of oil.