“Your theory is crazy, but not crazy enough to be true”, as quantum physicist Niels Bohr said. The fall in oil prices has spawned numerous theories, some crazier than others, about how US shale oil will react and what, if anything, Opec should do in response.
One school of thought is that lower prices are already having an effect on shale oil production in the United States, and that production will begin to fall, perhaps by the end of the year.
Evidence includes the bankruptcy of companies such as producer Quicksilver Resources last Tuesday, and the continuing fall in US drilling rig counts, now down 761 from last year’s 1809 rigs.
On what happens beyond this point, opinions diverge. Long-term shale pessimists believe the bubble has now burst. An overleveraged sector will collapse and prices will rise much higher – the oft-foretold oil crisis just deferred by shale, not put off forever.
Others, perhaps more numerous, have their crazy theory. They think this is the dawn of an entirely new era for oil prices: where shale oil production can be turned on or off in a matter of months, depending on prices. Shale oil wells can be drilled and completed quickly, but their production also declines fast, so continuous drilling is necessary to maintain output.
This is quite different from traditional fields, such as in the Middle East or North Sea, which take years to develop but have low operating costs and continue cranking out barrels even when prices collapse.
In this theory, the US has replaced Saudi Arabia as the “swing producer”, able to vary production within months to rebalance the market.
Of course, this is not intentional but the accidental effect of thousands of companies responding individually to the dictates of the market. In this view, the oil market would come to behave more like the US gas market, with prices oscillating on a timescale of a few months, rather than years, around some moderate equilibrium level.
It is hard to say what that equilibrium is – a range of $60 to $80 per barrel might appear reasonable, with oil services companies surveyed by Nomura expecting prices at $75 per barrel by March next year. At that price, global oil demand would rise moderately, shale oil production would grow at a more measured pace, and there would be room for Opec output also to rise.
But this opens proponents to Mr Bohr’s accusation that, “You’re not thinking, you’re just being logical”. Another school of thought, for example Ed Morse’s at Citigroup, suggests that US prices could go as low as $20 per barrel, as storage fills to the brim. The US’s ban on most crude oil exports leads to a growing divergence with international prices. on Friday, the US’s West Texas Intermediate was at $48.87 per barrel, the North Sea’s Brent at $56.41.
Oil service costs have already fallen 20 to 25 per cent, drilling efficiency continues to increase, much basic infrastructure such as pipelines is already built, decline rates have been slowed by new technology, and a backlog of new wells are just waiting for higher prices to be hooked up. Shales that needed $80 per barrel prices last year may now be viable at $60 or less.
Private equity giants such as Blackstone, KKR, Carlyle and Apollo are raising billions of dollars to invest in distressed oil company debt and equity. Companies such as Encana and Noble Energy raised $8 billion of new equity in the first quarter of this year, to fund continued drilling or the acquisition of weaker competitors.
So the world of shale oil may obey one of the principles of quantum physics – the mere act of observing it changes the situation. If companies and investors believe oil prices are going higher, they can raise money to continue drilling – and thereby prolong the price slump.
Robin M. Mills is Head of Consulting at Manaar Energy, and author of The Myth of the Oil Crisis