Hurts So Good: When Exactly Are Falling Prices Bad?

Townhall.com ^ | January 6, 2015 | Peter Schiff

[Riflema]

And what’s the life span of the newly frack’d deposits? 18mo, 24mo.? At $60 are they seriously going to gamble on moving the pipes around when so many people who entered at $100/barrel have just gone bust? Who’s going to lend to them at that point (seen all the articles about the the amount of leverage out there in oil plays?).

[1010RD]

Thanks. You’re a real gem.

[thackney]

And what’s the life span of the newly frack’d deposits? 18mo, 24mo.?

Typical well will flow for several decades. Not at the same rate as initially, but 30~40 years easy.

[thackney]

At $60 are they seriously going to gamble on moving the pipes around

I don't think you understand the production side very well.

[thackney]

I probably overstated the life span.

Say 25 years easy, 40 years or more maybe.

[Riflema]

Agreed. I know that a lot of costs are literally sunk, but there have to be significant marginal costs to frack a new area from the existing hole in the ground. All I'm saying is that $60 oil makes all that a lot more questionable than $100.

Which all gets away from my original point: the recent surge in fracking as an extraction method is a result of $100 oil, general deflation (aside from oil) actually is another driver to delay new exploration or new areas of production - delay means lower prices for the fixed equipment and the likelihood that temporarily reduced production will help raise oil prices. Almost no-one alive today has experience of deflation in a major economy, it will have the most peculiar effects on business decision making in general, and make businesses resistant to investment given that they will be very unsure on their returns.

[thackney]

Which all gets away from my original point: the recent surge in fracking as an extraction method is a result of $100 oil,

Do you understand, the drilling rig count, went significantly high before we reached those prices?

[Riflema]

Yes, it did grow very nicely early in the century, but I'd suggest this was simply new plays and better utilization of fracking+horizontal drilling being deployed. After that, if you graph price/rig count you'll see it follows price pretty clearly. That steady price rise in crude also suggests that this refinement of the process had no impact on price (it should lower it, right?). The rig count stayed high all he time crude was over $95.

Overall therefore, I'd argue that the fracking/horizontal implementation was NOT a productivity enhancement, it meant spending more effort/money to get the same output (regardless of the fact that the output would have been impossible without the tech). Getting more widgets/dollar of cost is productivity growth, that is the opposite of what the oil patch has been doing.

[thackney]

if you graph price/rig count you'll see it follows price pretty clearly.

No doubt that the higher the price of oil, the more folks invest money trying to drill for it. More rigs always get put in service when prices stay high for years.

better utilization of fracking+horizontal drilling being deployed.

That would explain a decline in rigs for the same oil price, not an increase.

I'd argue that the fracking/horizontal implementation was NOT a productivity enhancement,

Bad argument. Productivity per rig continued to increase in this time period.

Drilling Productivity Report, December 2014
http://www.eia.gov/petroleum/drilling/pdf/dpr-full.pdf

None of that supports any claim that hydraulic fracturing needs $100 to be profitable.

[ArcadeQuarters]

If your primary source of income is to skim the wealth that others create, then you benefit from high prices and the mindless consumption of others. If you’re actually productive, then lower prices and frugal spending raise your standard of living.

[Riflema]

Guess I’ll agree to disagree. Just try telling the bankruptcy courts that all is fine at today’s oil prices, looks like they’ll need a lot of expert witnesses in the near future.

[thackney]

I’ll share with you then number of well completed below $100 dollars.

I haven’t claimed all is fine. Several companies took on too much debt and depended on high prices that won’t happen at this time.

But that is far different than trying to claim hydraulic fracturing needed $100 to be profitable. Hundreds of thousands of wells were stimulated this way for decades when prices were under $100. It isn’t an opinion, it is history.

[Riflema]

Okay, I get that, there are plenty of well run, well capitalized companies exploring and producing uses these techniques. There are also dozens, maybe hundreds, of other operations that are neither. In this century wildcatter + easy money = problems ahead.

I'll try another approach: USA onshore discovery and extraction of oil has been getting more expensive in terms of effort and raw materials, not less. Of course, engineers regularly improve productivity at the margins, but in the big picture the cost/barrel curve point up. That is the very definition of declining productivity. I'm not a peak oil person, but surely we all know that US production is more expensive than say, Saudi, and over a timeframe of years that is not improving.

[thackney]

You need to understand that Saudi and the others don’t have an abundance of cheap oil either. They don’t have the production capability to replace all the recent oil growth the US has had over the past 7 years. Total OPEC surplus production capabilities, which is nearly all in Saudi, is a little over 2 MMBPD.

As an example of what Saudi Arabia spends to produce its next barrel of oil, look at what they spent recently.

$17-billion (significant overruns from estimates) on the Manifa project for 900,000 barrels a day.

Offshore in shallow waters, they built 27 man-made drilling islands, 13 platforms, and 15 onshore drillsites. The project includes 41 km of causeways and 3 km of bridges designed to maintain natural water flow in Manifa Bay. They have worked for over half a century trying to figure out a way to economically produce this lower value, high sulfur heavy oil with high metal content.

They don’t have the capacity to supply the world with “cheap” oil. They don’t have cheap untapped fields, they have expensive stuff like us. The old massive fields that built their empire are well aged and they spend significant dollars on Enhanced Oil Recovery methods like water flood to keep the production from them dropping to fast, but they are dropping. That is why they spend $17 billion to develop a new field with low quality oil.

http://www.bloomberg.com/news/2013-04-15/saudi-aramco-starts-pumping-from-manifa-oil-field-ahead-of-plan.html

https://www.saudiaramcoworld.com/issue/196006/manifa-oil.field.under.the.sea.htm

http://www.theoildrum.com/node/9056

http://www.oilandgasnewsonline.com/Article/33782/No_plans_to_raise_output_capacity

The price is not going to immediate jump back up to $100. But it will climb, because nobody has sufficient supply at the cheap prices those outside the industry dream of.

[Riflema]

I’m not sure we disagree here. The stuff is getting more expensive all over, not less. That is declining productivity (if you measure output in Bbl not USD).

[thackney]

I’m not sure we disagree here.

If you still think we need $100 oil for hydraulic fracturing to be a profitable stimulation method, we don't agree.

I hate making predictions. The oil price has already dropped farther than I thought it could in the past 6 months. But I do not see a long term (multiple years) with prices staying ~$50. They will climb over the next few years. $70? $80??, $90???

Unless something else greatly changes, like a really bad global economy where the demand actually falls for several quarters in a row. Or a dozen different things that greatly impact global price.

But in either case, hydraulic fracturing is not over in the US or the rest of the world.

Cheers!