For months Saudi Arabia was cagey about its oil strategy. The kingdom claimed its decision not to cut production and stop the slide in prices was solely about letting the oil market reset itself. That charade is over.
The Saudis now openly boast that their strategy to let oil prices collapse was an attempt to kill U.S. shale production. Citing the nearly 60% drop in the U.S. oil rig count since October and the slowing of U.S. oil production, they are claiming a brilliant triumph.
But rather than kill the U.S. shale revolution, the Saudis have only made it more resilient, sped up its rate of technological innovation and capped oil prices for at least a half-decade or more.
U.S. shale producers will survive and grow. American consumers, paying less for gasoline and heating oil, will be the big winners. The Saudis and their friends in OPEC, so dependent on oil-export revenue, will be the clear losers.
The U.S. shale industry is by necessity becoming more efficient than ever. Low oil prices have become an opportunity. The Saudis have lit a fire under producers to trim the fat, deploy new productivity-boosting technologies and zero in on the most productive geology.
Shale’s break-even price
Just a year ago, popular opinion seemed to be that shale oil production was generally unprofitable if oil prices fell below $80 per barrel. This break-even point was lower in some formations and far higher in others. But with prices well above $100, producers and oil service companies were simply racing to drill as many wells as possible. They were, as shale pioneer Harold Hamm remarked, running wide open.
However, weak global demand turned the oil market on its head almost overnight. Suddenly, investors saw a market awash with oil — with little economic growth to sponge it up. Prices fell and the Saudis made their gamble. Instead of cutting their production and forcing their OPEC partners to cut with them to prop up prices, they reasoned that U.S. shale production, and other high-cost output like deep offshore, couldn’t compete if prices were to fall into the $50 range for any extended period.
The Saudis assumed the $80 break-even price for U.S. shale was a firm floor. They further assumed that the American innovation and ingenuity that had suddenly turned shale rock — long deemed unproductive — into the source of an energy revolution, was complete. They assumed wrong.
Shale industry faster, stronger
For the shale producers, the fall in prices was a shock, but then came the response. Spending on new production was reined in. Contracts were renegotiated with oil service companies, reducing the cost of equipment, and only the best drilling and fracking crews were retained.
Statoil, for example, reported that just in a few months it cut its drilling time for new wells in Texas’ Eagle Ford formation from 21 days to 17. That kind of efficiency gain has helped “petropreneurs” reduce the cost of drilling wells from $4.5 million to $3.5 million.
Other companies are experimenting with new fracking fluids and different types of sand to create better shale-rock fractures. Some are effectively incorporating Big Data to better understand the sweet spots of geologic formations and optimal well-spacing to increase productivity.
The result is a rapid decline in the break-even price across shale plays. Already, analysts believe it is now $60 per barrel and before long will fall to $50.
Goldman Sachs now predicts that prices will likely hold at $50 for at least the next five years. Shale efficiency and innovation have created a new ceiling for the price of oil. This certainly was not the Saudis’ aim.
It’s been tempting to think the shale boom is over, that a fall in the rig count and a small dip in U.S. crude production signify that the high-water mark of U.S. shale oil has come and gone.
But, as the Saudis are finding out, we are just in the early innings of a new revolution — “Shale 2.0″ as Manhattan Institute fellow Mark Mills calls it. A strong, increasingly efficient and productive U.S. shale industry — powered by American ingenuity and “Made in the USA” drilling and extraction technologies — is here to stay.
Perry is a scholar at the American Enterprise Institute in Washington, professor of economics and finance at the University of Michigan’s Flint campus and creator and editor of the economics blog Carpe Diem.
from AEI » Latest Content http://ift.tt/1PNwb1Y