The Fuse

Shale Cannot Cover Shortages in Saudi Production

by Alex Adams | @alexjhadams | October 23, 2018

As the fallout from Saudi Arabia’s threat to weaponize its oil continues—with Saudi oil minister Khalid al-Falih insisting this week that the kingdom has “no intention” of repeating the 1973 embargo—the spotlight has fallen on domestic production. The rapid growth of unconventional oil production has created a narrative of energy complacency, suggesting supply is no longer a concern.

However, the current state of the shale industry, and unassailable oil market realities, tell a very different story. Rumblings of discontent among shale investors are growing as the search for returns continues, with the shares of most shale companies not rising with the rally in crude prices. The mounting frustration has led to activist investors calling for mergers, believing that consolidation is a promising solution for profits in a capital-intensive industry, where economical production has proved far more challenging than expected.

Collectively, 50 major U.S. oil companies reported in their second-quarter results that they had spent $2 billion more than they had gained.

Despite oil prices rising 40 percent to more than $70 per barrel, two-thirds of U.S. oil producers failed to live within their means in Q2 2018. Collectively, 50 major U.S. oil companies reported in their second-quarter results that they had spent $2 billion more than they had gained.

Further issues persist elsewhere within the industry. In addition to slower growth due to pipeline capacity constraints, production could fall short of its most optimistic predictions as well productivity falters. On a call with analysts, Schlumberger CEO Paal Kibsgaard said it was becoming more difficult to increase production as the shale patch matures and new wells are being sunk in areas that have already been drilled.

“The well-established market consensus that the Permian can continue to provide 1.5 million barrels per day of annual production growth for the foreseeable future is starting to be called into question,” he added.

Aside from pipeline capacity, the shale industry is now turning its attention to other bottlenecks in the supply chain. Crude oil export terminals are currently ill-equipped to handle rising U.S. export production, with only one port able to handle the large tankers used to ship oil to Asia and Europe. Permits have been submitted for a new oil terminal to be built in Corpus Christi, Texas, but concerns persist that there won’t be enough long-term demand to justify the building cost, reckoned to be more than a billion dollars.

The industry remains dominated by Saudi Arabia, its fellow OPEC cartel members, and additional OPEC+ petrostates.

In addition, the wider realities of the global oil market demonstrate that no matter how much oil the U.S. produces, it will always remain vulnerable to global oil price volatility. The industry remains dominated by Saudi Arabia, its fellow OPEC cartel members, and additional OPEC+ petrostates. Together, these countries—which share neither the free-market values nor the strategic priorities of the U.S.—hold approximately 90 percent of the world’s oil reserves, and leverage this advantage to influence global prices.

This leaves the U.S. exposed to oil price volatility. Despite domestic production reaching historic highs of 11 million barrels per day this year, the price of oil has still continued to rise, with gasoline prices growing considerably from their 2016 lows. Furthermore, the U.S. remains the world’s largest oil consumer, accounting for one-fifth of daily global supply, 70 percent of which is used to power an American transportation system that is 92 percent dependent on oil.

U.S. shale production also forms only a small fraction of wider global oil supply. An estimated 40 mbd of new output will be required worldwide over the next 6-8 years to offset the natural decline in existing oilfields, but $1 trillion in global upstream production investment was lost after oil prices slumped in 2015. Without timely investment, analysts are predicting a ‘decade of disorder’ starting in the 2020s as prices rise amid supply-demand mismatches, exacerbated by rising geopolitical risk.

Rising U.S. production has enhanced energy security by boosting exports and cutting imports, but comprehensive policy solutions are required to combat Saudi Arabia’s pernicious oil market influence. One such approach could be the No Oil Producing and Exporting Cartels (NOPEC) Act, which would create an explicit legal avenue to hold OPEC to account for its price-fixing behavior. Similarly, demand-side measures such as modernized fuel economy standards and encouraging alternative fuels such as electricity, fuel cells and natural gas will also help insulate the U.S. economy from oil price volatility.

When Saudi Arabia threatens to turn its production advantage into an oil weapon, the U.S. cannot afford to brush off this warning by overestimating the potential of shale to cover the shortfalls.

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