When we first started getting substantial oil from fracking and
horizontal drilling, the news about costs indicated that oil production
would decline at a fast rate when prices were low, pushing prices back
up. New data, however, argue for rising productivity of shale oil
development—meaning plenty of petroleum to keep prices low.
Price cycles vary widely across industries based on how much of total
cost is up-front expense versus on-going expense, as I explained in the
best book about economics for business.
When costs are mostly front-loaded (oil, airlines, ocean shipping) and
capital assets last a long time, then price cycles are volatile. Most
production continues after a drop in price, because the variable costs
of running the operation are low. In contrast, where startup costs are
low but operating costs take a large portion of revenue (retail,
restaurants, health care), price drops force some companies out of
business right away, protecting the remaining businesses from further
price declines.
The traditional view of oil economics is that most of the cost is
up-front: exploration (finding the oil) and development of the field,
which involves drilling production wells and setting up local
infrastructure. The actual production cost, which involves running
pumps, maintenance, and local transportation, is usually pretty low.
With these basic concepts, oil production would keep flowing even after
prices fell. A look at oil price history confirms the volatility of the
industry.
The oil revolution changed that thinking. Fracking is more expensive
than traditional production, and the benefits don’t last as long as
normal development costs. Thus, fracking pushed up the on-going
production costs relative to the up-front exploration and development
costs. As fracking becomes more common, oil production will be more
likely to fall when oil prices fell. (This is an oversimplification, of
course.) This new economics of oil production argues that oil prices
cannot stay too low, because production shuts down fairly quickly.
Now, however, we have some new information coming, reported in Mark Perry’s Carpe Diem blog. Perry has described the dramatic impacts of Bakken shale and new technology in a lengthy series of articles. In one recent article, Perry quotes an oil industry insider saying:
“Six or eight years ago we were estimating a recovery factor of just 3.5% in the Bakken shale reservoirs from our horizontal wells. With additional work, micro-seismic study, well production history, big data analytics, etc., we’re now estimating that we’re recovering 15-18% of the oil in place.” [The recovery factor is the proportion of total petroleum underground that can be brought to the surface.]
Perry also quotes an interesting Mark Mills article on Shale 2.0. Mills says:
“In recent years, the technology deployed in America’s shale fields has advanced more rapidly than in any other segment of the energy industry. Shale 2.0 promises to ultimately yield break-even costs of $5–$20 per barrel—in the same range as Saudi Arabia’s vaunted low-cost fields.”
The key technology, according to Mills, is big data. We know where
the shale oil is, and now we have data on the geological characteristics
of these fields. Mills writes, “At present, each long horizontal well
is typically stimulated in 24–36 stages, with, on average, only
one-fourth to one-third of those stages productive.” With better
analytics, effectiveness of stimulation (fracking) will increase,
pulling costs down.
It still looks like fracking has costs shifted toward production
rather than exploration and development. The new twist is that the
entire cost structure is dramatically lower. That means production will
continue even at low costs. The shift in recovery factors from 3.5
percent to 15 percent produces a four-fold increase in total production.
The oil price forecast, thus, stays low. I continue to think that $60
is a ceiling. The floor is determined by the extent of fracking. Right
now, it’s mostly a North American phenomenon, due partly to our geology
and partly to our legal environment. It could spread, but that will be
slow. Thus, don’t look for $20 oil any time soon. Though if the
government oil companies that control most of the world’s oil fields
were to run their operations rationally, then $20 oil is what we would
get.
http://www.forbes.com/sites/billconerly/2015/07/02/oil-price-forecast-shale-2-0-will-keep-supply-abundant/?ss=energy