TEMPEST IN THE ALASKA TEA POT REDUX
April 11, 2017 § 1 Comment
Here we go again. Presidents making decisions that are largely symbolic in the face of economic realities. The latest is a report that President Trump will shortly issue an executive order to promote oil and gas exploration and production in the Arctic and Atlantic.
I had previously written that President Obama’s 11th hour decision to ban future sales of leases in the Arctic would have no net effect on the industry in the foreseeable future. His ban on the Atlantic coastal waters was more interesting, in that it stopped at approximately the North Carolina border with Virginia. Interesting, because previous exploration had shown potential in the North Carolina waters, more so than Virginia. I think some exploration is likely as a hedge, but actual development will await the sorting out of the true impact of shale oil, as discussed below.
The industry has gone through a secular change. Predicting oil price has proven even more tenuous than in the past. When conventional oil (as opposed to the more recent shale oil) was the only product, oil price prediction entailed understanding the development pipeline, usually years in duration, while factoring in political instability in the oil producing nations. Further assisting the crystal ballers was OPEC, which manipulated prices to remain in the vicinity of USD 100 per barrel. Since about 2015 all that has gone out of the window. Shale oil in the US caused a halving and it has been seesawing around USD 45 ever since. What the future bears depends on the source. In the past, there had always been the outlier analyst predicting USD 200 or some such. But the consensus was in the low one hundred region. Now we have polar opposite predictions regarding supply and demand from the likes of Goldman Sachs and Morgan Stanley. Sort of the definition of uncertainty. Not the best climate for long term investment. More on that below.
Sustained low prices decimated the ranks of the shale oil producers, resulting in 100 bankruptcies and default on USD 70 bln in debt. But a new force has emerged. Major oil players with deep pockets, such as ExxonMobil and Royal Dutch Shell, have taken large positions. More importantly, those two plus Chevron are committing to USD 7 bln investment in 2017 (some estimates are up to 10 bln.) in shale plays, primarily in the Permian Basin. This is a giant leap from before, when the emphasis was on offshore development. This comes shortly after the Shell announcement of withdrawal from the Arctic “for the foreseeable future”. This withdrawal is from continued development of existing leases. That would appear to indicate a disinterest in any more leases in auctions, enabled by the reported President Trump order. In fairness, that does not necessarily follow. Even if they are backing off on development offshore, new leases will still be bought as hedges. This is evident from the recent robust lease sales in the Gulf of Mexico. This is in the relatively benign environment of the Outer Continental Shelf (OCS). But an Alaska lease is a horse of a different color. The costs and environmental risks are much higher and the time to first oil (forget gas; that is even more in the doldrums of price than oil) is double that in the OCS.
Uncertainty, with concomitant higher discount rates, particularly hurts long term plays. By contrast, shale oil plays are short term in the extreme. Due to the steep decline rates, new wells must be drilled to keep up the production. These wells take a couple of weeks, not years. When the prices drop, drilling can be curtailed and then picked up at the drop of the proverbial hat. This flexibility is a key to the resilience that shale oil has shown to saw tooth prices. Furthermore, breakeven costs have dropped dramatically. At first these were due to steep service company discounts, which in turn caused bankruptcies among the smaller players. The big boys will inevitably raise prices, especially now with the reduced competition. But the industry is seeing genuine technology advances dropping costs even in the face of the upcoming service price increases. These advances will continue. A Shell spokesman recently stated that they were profitable in the Permian at USD 40 and that “newer wells” were profitable at USD 20. There is little doubt the industry is “high grading” their prospects: mostly just the most productive areas are being exploited. I think that is sustainable until additional technology driven cost reductions bring the lesser prospects back into play in roughly the three to five-year time frame.
The foregoing arguments underline the point that with oil companies likely struggling to pay their dividends in a low-price scenario, shale oil is a good bet. Expensive forays into the Arctic with long term payouts will be off the table in the foreseeable future. Presidential actions on leasing are mere tempests in the Arctic teapot.
Yes, Shale oil – and gas – are the young hustler who beat the champ, aka Paul Newman vs. Jackie Gleason.
The champs, the majors, have a different mindset. They don’t really care if they lose a few bets for a billion or so. They work the deep deposits, spend billions and reap billions more over decades. It is a different play. Same tools, different rock.
Shale is a shallow play. You can get in and down for a million or so, especially in the Permian and Eagle Ford. Production costs are nominal. Yes, the initial production drops by 80-85% within 18 months, but this resultant production is still at a multiple of most other rigs and still very profitable for 5+ years. Once you get you production cost up the borehole, 90% of each next barrel is profit.
Excessive debt killed off the overleveraged shale producers and suppliers. Wall St. got hustled by Houston et again. Now the field is clean and slim and low cost. The survivors are taking full advantage of your well stated technology breakouts. Big data applications are yet to be fully applied to any of the fields. Fully automated rigs, multiple bore from one pad, advanced scanning for ‘shelves and sleeves’ of deposits, flex boring: these are simply the preamble for the next five years of tech apps.
XOM has tried for years to work the shallow fields of shale, to no avail. The mindset of a Tillerson is just wired differently from that of a wildcatter. Risk has two entirely different meanings to these two types. As for gas, demand remains high for a simple reason – the globalization of the supply chain. Now that Cheniere is producing – and expanding production – at its export facility in La., the demand cycle has finally become global. A localized commodity, one of the last, has become a global one. Pricing will respond to new stimuli, as you suggest for the crude markets.
Politicization of the delivery chain will be much more difficult, as it has been under the OPEC cartel. Unions and cartels are anachronisms for protection rackets. Globalization of TMT reduces such influence. The previous political cartel in DC proves the point. Even these scoundrels are being outed.
Big data, small players, TMT and risk players: this has always been the story of energy production. It is why government sponsored ‘alternative energy’ will always fail. Artificial demand falls upon its own tax credits petard. There is not need for such costly nonsense, as demonstrated by your commentary on Alaskan crude.
Natural gas production and distribution has done more than all the billions in government (aka your tax dollars) funding to shift America to a wiser, more efficient, energy production table. Now that it is the #1 source of electricity production in the US, perhaps we can stop killing the avian and bat populations of the planet.