SECOND SHALE REVOLUTION THREATENS OIL PRICE RECOVERY

Mark Blood - Mon, 20 Mar 2017

The global oil glut that has weighed on prices for more than two years looks set to continue into 2018.

US shale producers have ramped up production and OPEC, Russia and other non-OPEC states have failed to honour the output cuts agreed in Vienna in November.

Just as US shale frackers proved more resilient than expected during Saudi Arabia’s failed strategy of flooding the market with oil, so too has their rapid resurgence been grossly underestimated.

A re-born shale industry threatens to undermine OPEC’s efforts to stabilise oil prices and bring global production back in line with demand.

A cocktail of increasing output from the shale producers, cheating by OPEC and non-OPEC producers and a strengthening US dollar are creating near perfect conditions for another oil price slump.

And let’s not forget the rapid advances being made on the renewable side of the energy equation. Those who think that oil prices will climb above or even reach USD $60 in 2017 are dreaming.

Let’s examine the key factors at play here.

The Saudi view

At the recent CERAWeek conference in Houston, Saudi oil minister Khalid al-Falih admitted the Kingdom had been surprised at how quickly North American shale production had ramped up.

He agreed that world oil markets are likely to remain over-supplied for some time yet, and complained that some producers were cheating on their agreed production quotas. The November agreement stipulated that the thirteen OPEC and 11 non-OPEC countries would remove 1.8 million barrels a day from global crude production.

In his speech, al-Falih said Saudi Arabia would not allow itself to be used by others.

“We cannot accept free riders.”

His comments were principally directed at the non-OPEC members and Russia especially. Shipped cargoes suggest their compliance with the pledged cuts was barely 50 per cent in January and February.

Al-Falih is no ordinary energy minister and Saudi Arabia is the anchor and de-facto leader of the OPEC cartel. At the end of the day it is unlikely that any OPEC member will stray too far from the Saudi position. Despite quota cheating they will most likely adhere to the cuts agreed last November. Indeed a report by the International Energy Agency in February put OPEC compliance at close to 90 per cent of its share of the agreed production cuts.

Russia though, is a different proposition. It has no allegiance to OPEC and operates under its own rules.

Russia’s oil minister, Alexander Novak, has said it will deliver on its pledged cuts of 300,000 barrel per day by the end of April. However, parallels with Moscow’s promise to cut a similar amount in the late 1990’s - which it never followed through on - are looming.

In tacit acknowledgment of this al-Falih went on to say that his country would support cuts for only a restricted period of time - a strong indication that Riyadh may not agree to extend the quota agreement when it expires in June. If that happens, and the Saudi’s turn on the taps, oil prices will take a bath.

Shale oil producers that survived the market rout have done so by slashing operating costs, employing more efficient drilling and fracking technology and by exploiting the more productive parts of shale basins.

Major producing US shale basins

Break-even costs for the most prolific parts of the Bakken and Permian basins are now down to USD $35 per barrel and are forecast to go even lower.

Analysts are predicting that shale oil production will have increased by 600,000 barrels a day by the end of 2017, severely delaying the rebalancing of the global oil market. That may not occur until 2020 if similar volumes are added each year after that.

Wellhead break-even prices for major US shale basins - Rystad Energy

Faced with this production onslaught from the shale producers, one has to wonder what OPEC Secretary-General Mohammad Sanusi Barkindo was thinking when he told delegates at CERAWeek that the global industry is moving towards rebalance and that it is close to achieving this. How close he didn’t say.

What is not disputed is the shale industry’s rapid recovery. The US rig count stood at 768 on March 11 - almost twice the low point in May last year. And, according to Bank of America’s Max Denery, productivity per rig has increased 10-fold since 2008 for most of the shale basins.  

Because shale frackers are so agile, and have been able to quickly raise production since prices rose above USD $50, they may overwhelm OPEC and Russia’s efforts to stabilise the market and lift crude prices.

Yet there is another factor at work here too – Donald Trump’s ‘America First Energy Plan’ which pledges an energy revolution.

The US may already be experiencing its second shale revolution but Trump wants to go further by opening federal lands and accessing USD $30 trillion in untapped shale, oil and natural gas.

What insights can we take from all this?

Firstly, OPEC is discovering it cannot control the global oil market as they once did. As Margret Thatcher famously said “you cannot buck the market”. OPEC is learning that oil is no longer an exception to this rule.

A second learning is that the prospect of another oil price slump may become a reality. It was alluded to by the Saudi oil minister at CERAWeek. The global oil market glut which has depressed prices for more than two years looks set to continue into 2018 and possibly beyond.

The expectation of IEA executive director Faith Birol back in January, that the balance between supply and demand will be resolved by mid-2017, looks hopelessly optimistic.

Thirdly, investors and oil companies are becoming increasingly aware that the world is awash with oil and gas and that some of these reserves that underpin company balance sheets may become stranded and therefore worthless. This makes exploration in expensive deep water regions unattractive and economically pointless.

The theme of stranded oil and gas assets has been highlighted by Bank of England Governor Mark Carney. He recently warned investors of “potentially huge” losses from climate change action that could make most of these reserves “literally unburnable”. 

Indeed, BP’s latest Energy Outlook recognises that the rapid growth of renewables threatens not only frontier, high-cost exploration but also the exploitation of a large portion of today’s known reserves.

Implications for New Zealand

For New Zealand’s petroleum industry the implications are clear. The expectation of a resumption of exploration activity and expenditure to what it was before the 2014 downturn has rarely looked as uncertain as it does now.

A greater focus on cost-effective production may see renewed interest in acreage off the Taranaki coast but there may be less interest in developing new sources of supply in high-cost areas such as the country’s deep water frontier basins.

What does that mean for NZP&M’s continuing efforts to attract new entrants into these frontier areas?

Mark Blood has more than 30 years’ experience in the oil and gas sector and was previously exploration manager for Todd Energy. He is now chief executive and part owner of passive energy home builder QBuild,which holds the ehaus licence for the greater Wellington region.