Streetwise Professor

February 13, 2013

Fracking FUD From OPEC

Filed under: Commodities,Economics,Energy — The Professor @ 5:18 pm

There has been a great deal of optimism regarding the future of oil and gas production in North America, and the US in particular.  Fracking has already turned the gas world upside down, and is starting to do the same in oil.  The IEA has made very optimistic forecasts, and the main cloud it sees on the horizon is that the US is not investing enough midstream and downstream to absorb the unexpected upstream bonanza.  Citigroup’s oil analysts just released a similarly sunny prognostication.  (I usually don’t see eye-to-eye with Ed Morse on the speculation issue, but he is very credible on the fundamentals of the physical market.)

OPEC is taking a contrarian view in its latest monthly report:

In its latest report, the group of major oil producers forecast the shale boom in the U.S. would help increase oil production by 520,000 barrels a day this year, giving the U.S. the highest production growth among the non-OPEC countries, but it also played down the positive side of these developments by warning of the challenges facing the industry.

“There are remaining risks associated with the growth forecast on the back of weather, technical, environmental and price factors,” the report said. It said that the heavy decline rate associated with the first year of shale oil production from individual wells in the first year was a major factor that could impact growth.

The decline rates are well-known, and E&P companies are basing their drilling investments based on the best available information.  Yes, decline rates could be faster than assumed, but they could be slower too.  Moreover, the technology here is extremely dynamic, and there is a substantial potential for advances in drilling and reservoir management that could make the forecasts of IEA and others appear unduly conservative.   Learning by doing and the accumulation of knowledge on how to exploit fracking technology, generated by the experiences of numerous companies, lay the foundation for positive productivity shocks.

OPEC’s sour attitude on unconventional oil bears an uncanny resemblance to Gazprom’s initial reactions to shale gas, reactions that were hardly persuasive early in the boom, and which look more pathetic by the day.

It seems that like Gazprom, OPEC is trying to spread Fear, Uncertainty, and Doubt about unconventional oil, in an attempt to try to scare off investment.  Their efforts are likely to be no more successful than Gazprom’s.  The people committing the capital know more about fracking and the formations where it can be used than OPEC, and are learning more every day.

And while we’re on the subject of OPEC and uncertainty, perhaps it could address things it might actually know a lot about, like the reliability of Saudi reserve estimates and the effects of political risk on production in places like Venezuela and Nigeria.

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6 Comments »

  1. In the trading markets, we call this “talking your book.” OPEC, Gazprom, etc., can be relied upon to do so.

    One wonders what happens when the shale revolution goes global. Environmentally, it’ll be a lot of work to keep it from poisoning those parts of the planet where large-scale extraction occurs — that is a huge problem, but it can be addressed. But, at the end of the day, it shifts the center of gravity away from these producer countries and toward the consumer-producer countries like the U.S. and its anglosphere counterparts, perhaps along with China and eastern Europe. These consumer-producer countries have a huge incentive-based system that ensures the resource will be developed at marginal cost within a market-based framework. This system already produced the technology that made the shale revolution possible … i.e., which is to say, given a prolonged period of rent-seeking in OPEC and Russia, it is inevitable technology would displace the rentier states’ income engines. (There’s probably a great paper in here re how rent-seeking produces some Hegelian dialectic propelling the demise of the rentier state. What a delicious irony.)

    One’s mind reels at the geo-political implications of all this over the next 20 years or so.

    Comment by markets.aurelius — February 14, 2013 @ 5:14 am

  2. The technology improvement (learning curve) is crushing the faster well-decline rate in shales. It reminds me of the semi-conductor business, where Fabs get ridiculously expensive, and have shorter business cycles, but the cost per transistor, or per btu in this case goes down.

    Fracking and drilling costs are already less than a $1 per mmBtu, and most of the world pays more than $10/mmBtu for gas. It is massive opportunity for gas to expand into many energy markets that use or oil or coal for energy.

    See page 9 of this investor presentation by SW Energy to get a sense of the convolution of economics and technology. http://www.swn.com/investors/LIP/latestinvestorpresentation.pdf \

    In last 5 years of technological improvement, the fracking zone (lateral length) has doubled, while average drill rig time has dropped from 17 days to 8. Costs are dropping must faster than the cost of producing a marginal mmBtu.

    Rejoice that there is a facet of innovation in an otherwise stifled economy where entrepreneurs seek profit in washington. And better still, the Putin/Gazprom goose is finally cooked.

    Comment by scott — February 14, 2013 @ 5:18 am

  3. Scott – I don’t doubt that (for Southwestern in particular, and the industry in general) drilling technologies have improved immensely in the past few years. Indeed, that is exactly what you would expect given where the industry is on the learning curve. The shale boom really got going in the mid-2000s and the past five years or so are likely to be the steepest part of the learning curve. But do the math on Southwestern’s reserve to production ratios:

    Production = 437 Bcf/year, = 1.2 Bcf/day
    Reserves = 5,104 Bcf
    Reserve coverage = 11.7 years (at current production rates)

    Given that these producers indicate that a well will continue to produce for upwards of 30 years, the decline rates are necessarily extremely steep. While there will definitely be some optimization around well-spacing, lateral lengths, pad drilling, the like, the basics of the geology show that–rather quickly–the number of new wells required to keep production growing within a particular basin will outstrip the number of potential drilling sites per year. The boom isn’t ending anytime soon, and there are certainly emerging plays that will see increased activity, but the industry is getting close to the point of diminishing returns; that may not be in 2013 or even 2015 or 2017, but it is coming.

    Comment by Mitch — February 14, 2013 @ 7:38 am

  4. @markets . . . I used that phrase when discussing Deripaska in the aluminum post over the weekend. It often fits.

    Yes, the geopolitical consequences will be seismic. You can tell Putin is nervous about all this. Which will give him and the Russians generally an incentive to make mischief to try to impede the use of these technologies outside of North America.

    The ProfessorComment by The Professor — February 14, 2013 @ 5:42 pm

  5. […] OPEC, Talking it’s book. ($CL_F) […]

    Pingback by Breakfast Links - Points and Figures | Points and Figures — February 15, 2013 @ 6:33 am

  6. .Well, you know,de Nile is a river in Egypt (arabia)

    Sorry, couldn’t help myself.

    Comment by Sotos — February 15, 2013 @ 9:26 am

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