Monday, November 16, 2015

Oil's eventual recovery, part one

Right now we are experiencing something which has only happened twice in nearly 30 years, a greater than 50% year over year drop in the price of oil.  The previous event happened during the great financial panic of 2008 - 2009.  Today the US, China, or Western Europe aren't experiencing a severe recession, so what triggered this dramatic fall?  At it's simplest, supply exceeded demand.  The how and why is fascinating. 

Some quick charts describing the extent of the decline
Year over year percentage change in the price of oil.
Absolute price - Beside the dip to 40 during the great financial crisis, the last time US oil prices flirted with 40 dollars was in 2004.

So what caused the fall?  Note the graph below, showing oil production levels of the largest five producers up to 2014.   US oil production grew 15.9% from 2014 to 2013 (Source: BP statistical review) and not only was this the largest percentage increase in the world, it was also from one of the largest suppliers in the world.  In fact in 2014 the United States pumped more oil than any other country in the entire world. From a nadir in 2005, US production rose nearly 70% by 2014 -- a increase of more than 4.7 million barrels a day.  Additionally total world oil production increased by ~2.3% in 2014.


Demand did not keep pace with supply however. 


Note the graph above hasn't shown a decline in world crude oil demand since the great recession; instead supply outstripped demand and prices fell.  Saudi Arabia exacerbated the situation by pumping even more oil. (I'll speculate as to WHY later)
Saudi Oil Production

Remember all that talk about Peak Oil so many years ago?  American oil companies evidently didn't read the articles calling for the death of oil production. 
Source: Google Trends

The internet keeps track of almost everything now, so make your predictions carefully.

Even the New York Times piled onto this theme; stating Malthus was eventually right and we'd better get used to it (Peak Oil)

While I may appear to be picking on these predictions, and I am (a little) I would rather highlight how hard it is to make predictions, especially long term forecasts.  I will make a few in later missives.  Be careful with those. 

So how did the US reverse the inevitable decline in oil production?  A technique called fracking (aka shale oil or tight oil) altered the cost structure and timing of extracting oil and natural gas from locations previously thought to be uneconomic.  

Below is a quick video and some additional links describing the technique:

Fracking can resonate for some of my readers as an especially dangerous form of petroleum extraction.  The linked video is from an oil company, so they will show the process in a positive light without discussing any of the possible downsides. (Such as waste fluids intruding into water aquifers)  Google any of the terms and you'll find a strident debate regarding the safety of this new technique.   

Regardless of the safety of the process or whether it should be employed at all, fracking and tight oil extraction techniques are currently legal in America and from my reading of the current regulatory climate will remain so.  Even a recent EPA report on fracking provides fodder for both sides:  

Fracking allows for the extraction of oil and natural gas from areas previously thought uneconomic.  New wells are  drilled very quickly and productivity in drilling speed and initial flow rates continue to rise.  Specific examples are always illustrative.  (source: )

Notice on the upper left image how initial oil flows increased from less than 100 barrels a day to ~800 barrels in the Eagle Ford region (Texas), a greater than x8 increase in productivity!  This has catapulted Eagle Ford production to more than 1.2 million barrels a DAY. On its own the Eagle Ford today would be considered one of the top 20 countries in the world for oil production from nearly nothing in 2010.  Scroll through the linked report above and you'll see comparable increases in both natural gas and oil for other regions of the country.

One can also see the quick drop off in production for both oil and natural gas since the collapse in energy prices.  The rapid decline rate (more on that later) from these new techniques is both a blessing and a curse The game has changed, and OPEC knows it.

This new technology (fracking) has disrupted the oil production regime, creating a new potential avenue of supply not only in America, but the rest of the world.    How this new technology changes energy pricing as well as geopolitics is too much for just one post.  I'll try to dissect the situation later.