USA shale drillers versus OPEC

The 2017 oil market seems to be coming down to a battle between US shale developers and OPEC plus Russia. In this post I will ramble on about what I can see from 30,000 feet, without getting into a lot of technical details. The only conclusion I can reach is that oil prices are likely to oscillate around $63 per barrel for a while (say three years) and eventually will begin to climb towards a $75 to $100 per barrel range in the 2020´s. 

Hydraulic fracturing a well in Texas 

To understand what´s going on, it´s useful to understand the so called US “shales”. These rocks aren´t really shales. They are very low quality rocks, a mixture of shale with carbonates and sometimes silts and very fine grained sands. 

The quality of these rocks is so poor they weren´t produced much until the oil industry fine tuned a combination of horizontal wellbores which are fractured numerous times using sand, water, and a few chemicals (the “poisonous chemicals” the antifracking lobby likes to whine about, which happens to be quite irrelevant given that fracturing takes place thousands of feet below the surface and the fluids are pumped through very high strength concentric steel pipes). If you want to read a bit more about fracturing, go here:  Drilling Contractor Magazine describes greener fracturing .So... from now on, let´s call these “shales” even though we know they aren´t real shales, to makes things easier for the audience.

Anyway, the existence of the shales was well known for decades, but they were barely produced because they were lousy and we didn´t know how to drill horizontal wells and fracture the hell out of the rocks. Nowadays the oil industry doesn´t have much oil left to produce in conventional fields, which means there´s a lot of focus on the shales, which in turn means the tools and water and sand mixtures have improved a lot. And this means each horizontal well gets to produce enough oil to justify the investment (which ranges between say $4 million and $7 million per well)….if the oil price is high enough to cover the costs and allow for some profits.

The USA seems to have three world class shale rock regions, two in Texas (the Eagle Ford and the “Permian”, which for the most part means the Spraberry/Wolfcamp), and one in North Dakota (the Bakken/Three Forks).

The Bakken was developed very aggressively over the last 10 years, peaked at 1.15 million barrels of oil per day (BOPD) during 2015, but nowadays it produces about 950 thousand BOPD, and it´s unlikely to ever return to the previous peak. The best spots in the Bakken have been drilled, and lots of new wells can´t be justified at the current prices (some wells can be drilled, but they aren´t enough to offset the decline from the thousands of wells already producing).

The Eagle Ford seems to be maturing as well, although has some legs left. As it turns out the Eagle Ford production peaked at about 1.7 million BOPD, and now it´s producing about 1.1 million BOPD. The Eagle Ford can recover somewhat, but it´s doubtful it can ever return to the previous peak.

The other large shale target is in Texas´ Permian Basin. The rocks they drill are called the “Spraberry” and the “Wolfcamp”. These two have been nicknamed the “Wolfberry” and are probably the 800 pound gorilla as far as USA future oil production is concerned. This region has been producing slightly over 2 million BOPD, and can eventually increase production to say 3 million BOPD. The combined production from the shales and remaining conventional oil may take Texas into the 5 million BOPD range, which will make it the fifth largest oil producer in the world (behind Russia, Saudi Arabia, Iran and Iraq?). 

To get a bit more information about these shales, please go to this site Permian Basin overview (this gets pretty technical)

So let´s summarize: the USA has lots of shale zones to drill and fracture. Some of these are gas prone and I´m not going to get into gas, so let´s set them aside. The others are a mixed bag, and the only one which appears to have large solid legs to compete with OPEC at today´s prices (say $55 per barrel) is the Permian´s “Wolfberry”.

So now let´s look at OPEC´s data as reported in their just released March report:

Table prepared using OPEC´s March 2017 Market report.

The table shows 2016 production, and OPEC´s 2017 worldwide forecast. However, they are very cagey and left out their own OPEC crude oil forecast (that´s the production they play with to try to control oil prices). To finish the table I added the OPEC production in 2017, more or less. This figure, 31.8 million BOPD,  is a wild card because OPEC has very unstable members such as Libya, Nigeria, Venezuela, Iraq, and Iran. And nobody knows what they´re going to do for the year. The data in this table was summarized in the following graph, which shows the projected oil production for 2017, excluding the Permian shales. It also shows the worldwide market demand versus supply (the market balance). It seems that, if OPEC holds to 31.8 million BOPD, and US shale drillers don´t go nuts, the market will be undersupplied later this year, which in turn may drive prices up into the $60 plus range. 

World wide supply excluding the Permian and total market balance

Let´s recall the table above shows my own wild guess at Permian production in 2017. This line item is highlighted in a separate graph because it´s the only one I think can really fight it out with the large solid OPEC producers (Saudi Arabia, Iraq, Iran, Kuwait, and the Emirates). The production graph for the Permian, 2016 history and my guesstimate are shown here: 

Texas Permian production 

Let me repeat this message: IF OPEC can hold production at the “agreed” level (about 31.8 million BOPD, a figure they didn´t really agree but seems to be used by some pundits), and if US shale developers don´t go nuts,  then the market will definitely be undersupplied by the second semester 2017. And this implies oil prices will rise, to say the $60 per barrel range. 

The price increase we may see in the second half of 2017 will in turn will encourage US shale developers, which will focus on the Permian and increase its production. It´s evident US shale developer´s behavior will depend on their (and their banker´s) perception  of future oil prices. Which in turn will depend on the market being balanced (or underbalanced). 

If prices go up too much then US drillers will behave as they usually do, pick up rigs, increase production, which in turn will overbalance the market and cut prices. Which in turn will lead to lower production in the USA as shale developers simply lack the legs to keep it up at $50 per barrel.

Does this help a little bit? What conclusion can we reach from all this verbiage and numbers? That OPEC will be in a pickle unless they hold production below 32 million BOPD. And that US shale drillers will slice their own throats if they start picking up too many rigs once they see oil prices reach $60 per barrel.

This balancing act will continue for a while, but eventually, in less than three years, we should see the quality of wells being drilled in the US shale provinces start to drop (this will be more pronounced in North Dakota´s Bakken, Texas´Eagle Ford, and minor targets such as Okahoma´s SCOOP). 

There is simply a limit to the rock volume available to drill. And this means that, once we get to say 2020, we should see oil prices begin to rise towards a more “acceptable level”, or beyond the $60´s towards the $75 to $100 range I mentioned above.

 This outcome can´t be avoided because oil fields all over the world are being depleted, and very few countries have the untapped rocks left to make a meaningful impact on world oil supply (Brazil, Canada, Russia, Kazakhstan, and some OPEC countries have a bit left, but Venezuela is sort of its own basket case, with declining production which is unlikely to ever recover unless the Maduro dictatorship is overthrown, in spite of having very large heavy oil resources). 

The US and other shale provinces will help sustain or even increase worldwide production for a while, but eventually the party is simply over, prices will rise and we should see the competition (electric vehicles, biofuels?) start eroding the oil market. This will happen within the next decade or two, it has very little to do with CO2 or global warming hysteria. It will be more related to market forces and the fact that oil fields don´t grow on trees.