Kemp: Forecasts For Higher Oil Prices Misjudge The Shale Boom

Ignoring Shale

The problem with Hamilton's analysis is that it largely ignores the impact of the shale revolution on the economics of oil production and understates the tremendous variability in real oil prices in response to changes in technology.

The professor devotes just 400 words out of almost 4,000 to discussing the production of crude oil and gas from shale formations.

Most of that discussion focuses on the high cost of drilling and fracturing shale wells; the rapid decline in production; the alleged unprofitability of shale wells; and question of whether the conditions that produced the shale revolution in North American can be replicated in other parts of the world.

But this part of the paper is also the weakest, and it highlights the fundamental limitations with Hamilton's entire argument about the increasing difficulty and costs of producing crude oil.

Peaking Oil

Since 2008, the dramatic increase in oil and gas production from shale formations in North America, and the abundance of shale resources around the world, has discredited theories about peaking oil production.

The simple theory that supplies will run out has been reframed as a more sophisticated one about rising prices.

Peak oil supporters now point to the increasing cost of oil production, diminishing energy return on investment and the diminishing energy return on energy invested to claim that it is becoming harder and more expensive to sustain, let alone increase, crude output.


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WHAT DO YOU THINK?


Generated by readers, the comments included herein do not reflect the views and opinions of Rigzone. All comments are subject to editorial review. Off-topic, inappropriate or insulting comments will be removed.

oilprice  |  October 14, 2016
Pretty funny reading how confident Kopits was.
Todd  |  August 04, 2014
The transport vehicle manufacturing industry and major operators of vehicle fleets are just now embracing the fuel-saving technologies available to them. It is already slowing global demand growth for liquid fuels, and soon it will cause demand to fall. This is what will keep crude oil prices from continuing their upward climb. There will be no signficiant new sources of easy, conventional, low-price crude coming to market ever again. All the new production will be difficult to produce, remote, risky, high-tech and very expensive. Shale oil will form an effective, historically high price floor below which crude will never fall again.
Philippe  |  July 30, 2014
The business of producing oil, gas and NGL has changed and is changing. The majors used to pay royalties from their production. Majors used to have a free hand at managing their production. Today majors have been forced to enter JVs with local governments. In many cases the majors are minority within the JV. None the less the majors must provide the capital, up front. In some JVs the majors get paid by the initial production for a pre-determine period of time. After, let say, 5 years the majors are nothing more than the manager of the production and get paid for managing and maintaining the production infrastructure. The real owners set the production price, but this price is political based. OPEC is the best example, the price of Brent oil is as high as the world economies can bear. The threshold of too high price is when the price of oil causes a world economic recession. The price is further hedge on the price of gold, so any inflation is under controlled regardless of the currency used. So far this hedge is 12 barrels = 1 ounce of gold. The shale play has modified the capital required to entertain a profit faster. So far the shale play is onshore and do not require the billion dollar capital up front to show a profit. Drilling a horizontal well requires from $3 million to $5million depending on the depth, the number of stages and the length of the horizontal to be bored. Add several more million dollars for the infrastructure and the potential profit are present. The shale play requires the drilling of new wells, so as to cover the geological formation. The capex is sent over 5 to 10 years, not up front as with standard reservoir play and especially offshore project. Shale play permit the capex to be managed as profits develops over time. The risk management is absolutely controlled. This capex puts the investors in charge regardless of the government taxation or JVs internal business conditions. In many cases the government, majority player in the JVs will find resistance from the minority by scaling down the capex should the conditions become abusive? The majors will no longer be hostage to the upfront capital. The natural gas has conveniently been linked to the BTU of crude oil. The Henry Hub price is a standalone price not linked to oil. The world price of Natural Gas will be lower as the US Natural Gas as the LNG production comes on line. Already several contracts are based on Henry Hub price plus a fix percent. Overall the price of Oil or Gas will be more competitive world wide, more friendly to the end user. This does not mean that oil or gas will become cheap, the price variation will stay under control. The many potential sources will decrease OPEC control over the world price.
Steven Kopits  |  July 29, 2014
Jim Hamiltons paper is correct in all material respects. Let me add just one comment: "North American shale is currently the marginal source of supply in the world oil market..." This is untrue. The marginal barrel is probably deepwater, Arctic or oil sands. Goldman Sachs estimates the free cash flow breakeven for the oil majors at $100-130 / barrel, thus the IOCs are the high cost producers and the marginal barrel. If Johns thinking is correct, then the IOCs will be squeezed off their projects as lower cost shales displace higher cost initiatives. Shales have not, however, materially reduced oil prices. In fact, Brent is largely unchanged for the last three years; and WTI is $4 higher than in 2011 or 2012. In the US, surging shale production has been associated with increasing domestic oil prices. And yet, the IOCs are still reducing capex, suggesting that they are unable to control costs. If Johns scenario is right, and prices collapse as well, then IOC oil production is set to implode, and its hard to see how the global oil supply can be maintained, much less expanded, under such circumstances. A collapsing oil supply is not consistent with low oil prices. As I stated back in January (and much earlier), shales are no threat to deepwater. Rising E&P costs are. [John - feel free to reach out to me. Im writing a book on supply-constrained oil markets analysis. You can reach me at steven.kopits@prienga.com]
Rusty  |  July 29, 2014
This article seems to agree with, not refule, Hamilton. The only refutation is the unsupported statement, "most producers claim they can break even at $70 or even $60 per barrel."


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