The most important thing to understand about the coming oil production cutbacks

Resource Insights ^ | JANUARY 25, 2015 | KURT COBB

[thackney]

What the current oil price slump means for world oil supply is starting to emerge. "Layoffs," "cutbacks," "delays," and "cancellations" are words one sees in headlines concerning the oil industry every day. That can only mean one thing in the long run: less supply later on than would otherwise have been the case. But perhaps the most important thing you need to understand about the coming oil production cutbacks is where they are going to come from, namely Canada and the United States.

Why is this important? For one very simple reason. Without growth in production from these two countries, world oil production (crude oil plus lease condensate which is the definition of oil) from the first quarter of 2005 through the third quarter of 2014 would have declined 513,000 barrels per day. That's right, declined. Including Canada and the United States, oil production rose just under 4 million barrels per day.

That means substantial cutbacks in the development of new oil production in Canada and the United States could lead to flat or falling worldwide oil production.

But, why will any oil production cutbacks come primarily from Canada and the United States? For another very simple reason. Post-2005 oil production growth in these countries came from high-cost deposits in Canada's tar sands and in America's tight oil plays. New production from these high-cost resources simply isn't profitable to develop in most locations at current prices.

Of course, there are various figures floating around about what price level will allow new production to proceed profitably in these deposits. Some of those figures closely match current oil prices. But, we should look at what the oil companies are doing, not what they are saying. And, what they are doing is cutting back and cutting back drastically. Recent U.S. rig counts dropped the most since 1991, and rigs are being withdrawn from the very areas that were responsible for the tight oil boom.

Earlier in January Canada's largest oil company and a major oil producer in the tar sands, Suncor Energy Inc., announced layoffs, a cut in its capital budget and delays in new projects. Others are doing the same.

If the low prices continue, even more of the previously anticipated new production from these deposits will be delayed while production continues to shrink in the rest of the world. The twin North American engines for growth in the world's oil supply would stall.

If the world economy goes into a long-term slowdown or recession, then oil demand will ease further. That would mean lower prices would stick around for a while. But eventually, when growth accelerates, the pressure on constrained supplies may become acute and prices could spike.

By then, much of the workforce and machinery needed to increase production will be idle. But, probably more important, lenders and investors will be reluctant to risk money on tight oil and tar sands projects that only brought them grief the last time around. In all likelihood lack of capital will be the primary hurdle for Canadian and American operators when they attempt once again to ramp up production.

Even if oil prices recover soon to levels that would normally reassure lenders and investors, the growth in new production of U.S. tight oil and Canadian tar sands oil may only return to the hypercaffeinated rates of last summer several years from now after the memory of the recent financial carnage has faded.

Each day that oil prices stay low heightens the risk that the world will soon experience flat or falling worldwide oil production--something the oil supply optimists said simply couldn't happen with these new oil resources now available to us.

[Old Sarge]

There’s a lot of “if’s” in that narrative.

Do I take the upshot of this, that pump prices falling to levels less painful to consumers, translates as disaster later on?

[thackney]

I read it as the lower and longer the dip in prices, the higher and harder the coming spike in prices.

This fall in prices has been fast and far. Not the best way to have a lasting impact.

[nathanbedford]

Much of that uneconomical production that is At $40 to the barrel can be profitable at $60 or $80 the barrel. Thus, these swings create their own counter pressure.

For example, the author notes that if the economy of the world deteriorates so will the price of oil. But a shrinking price of oil is one of the best stimulants to the economy, the counterforce is created.

As trends of increased price of oil become recognizable, drillers will simply accelerate drilling. That acceleration will itself clause a slowdown in the increase in the price of oil, a countertrend having effect.

Finally, the challenge is to properly assess the lag in swings. In other words, the price of oil will no doubt sink below where there is an oversupply and momentum will simply carry it past that point. There will be a reaction, of course, and the tendency will be to over drill and overproduce causing yet another overreaction. It's a little bit like steering a sailboat in which there is always a tendency to over correct the course against the compass. A pilot with experience flying small planes will recognize the "lag" factor and learn to anticipate the overcorrection and compensate for it.

We certainly must recognize that the economic benefit to the world economy of cheap oil far exceeds the harm caused to the world economy by hard times for individual companies in the oil patch. The oil patch has been dealing with these problems since John Rockefeller played robber baron and will do so now.

[DallasGal]

I know you aren’t seeing a slowdown...but your work is mostly on existing sites, right? You said y’all are still hiring, so I’m at a loss to understand some of this. I haven’t been listening to the news for a couple of weeks so I’m not sure what is happening here.

[MeneMeneTekelUpharsin]

Oil will go down to at least $30 a barrel.

[crusty old prospector]

Our division went from four rigs to zero. Not much to do in our office but wait for bad news. We don’t have any wells to drill at all that are commercial below $75 a barrel.

[Old Sarge]

So, Newton’s Third Law applies with economics as well...

[thackney]

Are you betting your own money on that?

http://online.wsj.com/mdc/public/page/2_3028.html?category=Energy&subcategory=Petroleum

Lots of money to be made if you are right.

[thackney]

the challenge is to properly assess the lag in swings.

It is significant. Oil prices has been falling for half a year while the US production rate continues to climb, although slowing down.

[Fightin Whitey]

Where’s your general location, if you don’t mind my asking.

[Senator_Blutarski]

Prices fall and supply drops. Prices rise and supply increases.

Low prices cause high cost producers to halt money losing production. High prices allow high cost producers to expand production.

People, businesses and jobs are affected by the swings.

What a surprise! Capitalism and free markets are messy, but they are efficient and rational. Contrast that with the DMV or the Dept of Education...

[nathanbedford]

As long as wildcatters and entrepreneurs can drill with other people's money, they have strong incentives to do so. So the lag is extended. Then the venture capitalists shut off the spigot and demand begins markedly to exceed supply generating an overreaction the other way. Working against this tendency, of course, is the power of anticipation in which the market usually thinks at least six months ahead of today and investors believe that they understand the lag and can properly time the swings.

Ain't capitalism wonderful. It is these imponderables that cause disruptions and hardship in the market but also for consumers and workers, thus offering an opening for the left to come in and claim that they can smooth out these lags and catapult us into a land of rainbows and unicorns. That's how we get the great recession and $18 trillion national debt.

[Buckeye McFrog]

It’s how the oil industry has worked since Colonel Drake sunk his first well in 1869.

[nathanbedford]

You're preaching to the converted on this issue. On January 23, 2015, I posted a reply concerning the need to inflict casualties in the war against militant Islam as follows:

We must be willing to inflict casualties without regard to fastidiousness over collateral damage. We must take the attitude that we took in World War II that Germans and Japanese dying in their tens of thousands in bombing raids were paying the price for their folly in putting those regimes in place.

However, there is a huge moral difference between inflicting civilian casualties out of revenge and inflicting those casualties as collateral costs of victory. And it is quite another thing to say that one wrong justifies another. Finally, we have spent virtually every day since 1945 telling the world how heinous the Germans behaved while we turn a blind eye to the atrocities committed by leftists.

When we unequally lose these propaganda battles, we tend to lose the battle about who writes history and therefore we lose current events.

[Old Sarge]

Forgive the temporary brainphart, but what did that have to do with the price of oil? Or was that destined for another thread?

(I’ve been guilty of cross-post myself...)

[nathanbedford]

Brain fart indeed, I don't think even Professor Irwin Corey could make that connection.

Sorry for the cross post.

[Old Sarge]

And for the record, I agree with the cross-post fully.

[crusty old prospector]

Well, it ain’t the Permian, Eagle Ford, or Bakken. That’s all that we are drilling for the most part.

[nathanbedford]

thanks.