A recent piece of belief-based propaganda, designed to dovetail perfectly into society’s main belief in technology, ran in the Wall Street Journal. Based on the comments it generated, it scored a bull’s-eye.
I’m going to pick this piece apart one belief or fact-free assertion at a time. The reason this is important -- besides using it as a teaching tool to expose the degree to which thoroughly debatable, if not blatantly false, ‘facts’ masquerade as truth through the mainstream press -- is because such unchallenged views are hindering our ability to confront reality as it exists.
Here’s the opening salvo:
The Oil Price Swoon Won’t Stop the Shale Boom
Oct 23, 2014
[T]he current slump sets the stage for what I call America’s shale boom 2.0.
Three factors make it unlikely that the decline in oil prices will bring the shale revolution to an end.
First, shale production is profitable at today’s lower prices. We know this because the boom began during the Great Recession years of 2008-09, when prices fell below $50 a barrel. The price U.S. shale producers got for their oil during the boom averaged around $85 to $90, even though the world price stayed well over $100.
(Source)
For starters, the author calls for a “shale boom 2.0”, which is hugely appealing to people already in love with technology. “2.0” always means something better, more evolved and more advanced. It’s way better than “1.0”, right?
And yet, the more subtle reader can detect an underlying current of concern in the author's tone. Even though there have yet to be reports of lower oil production out of the main shale plays due to falling oil prices (or any other factors), the author feels it necessary to immediately begin listing factors as to why the shale revolution will keep chugging along.
But who exactly has been warning about an imminent production drop-off? Answer: no one. This is a strawman argument of the most common variety. Even if not one single new shale well is drilled from here onwards, the existing wells will continue to produce oil for years, albeit in ever diminishing quantities.
So the author already wins. No matter what happens next, for the next decade or more he can always claim that shale oil is still flowing.
But the real problem in these opening lines is the claim that “we already know shale oil is profitable below $50” simply because oil prices briefly fell below that mark in 2009.
First, the shale oil producers, as a collective industry, have not yet turned in a positive year of free cash flows since 2009. They have reported profits, but all sorts of accounting gimmicks can show a ‘profit’ even when a company is burning through cash at a faster rate than it is earning it.
Perhaps for a year or two this can be perfectly reasonable. But what are we to make of a shale industry that is now 7 full years into its ‘miracle’, and yet cash flows remain persistently negative? Since the wells deplete ~90% in 3 years and the best spots in the play get drilled first, shouldn’t we expect that they’d be generating oodles of free cash flow by now?
I mean, heck, if the author’s claim is valid, and “we know” that shale operators are profitable at $50 a barrel, then what is the explanation for the huge losses over the past 5 years as oil has persistently traded above $90 per barrel?
The reason we saw so much drilling in 2009 was because the shale operators had spent an enormous amount of money locking up shale leases when oil surged to $147 a barrel in 2008. At that time, they faced the choice of either drilling and losing a little bit of money, or not drilling and losing the entire value of any leases which had “drill or forfeit” clauses (which was most of them).
So maybe the fact that shale operators were drilling like crazy back in 2009, when oil was briefly below $50, isn't the slam-dunk evidence our author hoped it was.
Let’s move on to the next part of his article:
Second, shale production is getting more efficient, which means that profits are possible at prices even lower than today. Smart drilling techniques—horizontal drilling, hydraulic fracturing and information technologies that accurately locate where to place rigs and enable precise steering of the drill through meandering horizontal hydrocarbon-rich shales—are far more productive than when the boom started.
According to the Energy Information Administration, the quantity of shale or natural gas produced per rig has increased by more than 300% over the past four years. This rise in productivity matches (in equivalent terms of capital cost per unit energy out) the improvements in solar power, but it took 15 years for solar’s gains. Solar is now experiencing a slow-down in efficiency improvements; there is no sign of a slow-down in shale technology.
Ooooooh. He mentions “smart” technology, which is everybody’s favorite kind. It's hard to argue with smart technology. (sarcasm off.)
While it's true that there have been improvements in the past few years, the technical efficiencies he mentions here have been with us for many years. Horizontal drilling and hydraulic fracturing are decades old.
Where he goes completely off the rails is to then ‘prove’ his point by noting that the EIA says that ‘per rig’ drilling productivity has gone up by 300%. While I have not vetted this number (yet) to ensure it's accurate, it’s a misleading number to cite when talking about the role of technology in oil production.
The "smart" innovations he's touting are used in individual oil wells. But then he cites the ‘per rig’ data, and rigs are used to drill multiple wells per year. Is it that the individual wells are producing 300% more (as he implies), or that the rigs are able to drill more wells each year?
That is, if a rig used to drill 5 wells per year but now it can drill 15, there’s your 300% increase -- without anything at all changing in terms of how much oil will eventually be extracted from the underlying individual wells.
In fact, the main reason that the ‘per rig’ productivity has gone up is because the industry has switched from drilling one well per ‘pad’ to drilling multiple wells per pad.
A pad is a 1-10 acre flattened, gravel lot upon which the drill rig is parked so that it can bore down into the earth. By not having to move rigs from pad to pad, but just shifting them a few feet in order to drill a new well off in a new direction, has saved a lot of time.
This is a process improvement, not a technology improvement. I think it’s all very well and good that the industry has found a way to be more productive and not move the rigs around as much, but it's absolutely wrong to claim that this is the same thing as proof of the inexorable rise of increasingly superior technology to yield more more petroleum from the ground that other means would give.
But people love to hear about how technology always saves the day. And so people gobbled this part of the article up, mainly because the assertion fit into their preferred belief system. I wonder how many people have regurgitated these ‘facts’ about the role of technology in boosting shale output?
My guess is quite a few.
On to the third factor:
The third factor is the profound economic leverage afforded by the enormous scale and diversity of America’s hydrocarbon infrastructure. Many oil-producing nations have only a few big oil fields and a handful of companies, sometimes just one. The U.S. has dozens of world-class fields, thousands of production companies, tens of thousands of related businesses, and millions of miles of pipe and rail.
Among the thousands of shale producers, you can guarantee there are pioneers just like those who started the shale revolution. As profit margins erode due to low or even lower future prices, the pioneers will try out the revolutionary new shale techniques that have yet to be deployed.
I have to confess, I don’t even understand what the third factor is as described. It’s a lot of jargon and buzzwords put together. What exactly is “profound economic leverage afforded by enormous scale and diversity”?
It sounds good in the same way that Twinkies taste good. Unfortunately both are more than a few ingredients short of a well-rounded meal.
He gets down to it in the last sentence there, which basically boils down to – you guessed it! – another expression of his faith in technology. More companies vying for shale oil means more pioneers to try out the next great technology (which, presumably, we don’t even need because shale oil is profitable at $50, according the author).
When someone claims that any rough spot in the shale patch will be met with “revolutionary new techniques that have yet to be deployed”, you know you're getting out pretty far on the hopium branch.
I would remind people here that the South Sea company, the stock shares of which bubbled up enormously -- even causing Isaac Newton himself to lose the then-staggering sum of 20,000 pounds -- was billed as “a company for carrying out an undertaking of great advantage, but nobody to know what it is".
Those sound too similar for my taste. Ungrounded hype is the same thing no matter when it happens.
In Part 2: The Hard Facts About Shale Oil, we reveal in detail the facts behind the reality within the shale oil industry: the economics of production, the technology (where to place hope and where not to), as well as the impact shale oil production will have on the larger Peak Cheap Oil outlook. Suffice it to say, not only are shale companies not profitable at $50 per barrel oil; most are not profitable at prices nearly 100% higher than that.
So if they persist much longer, today's lower oil prices are going to create a world of hurt for quite a large number of shale operators. And shale-rich regions like North Dakota and Texas will discover what the opposite of ‘oil boom’ feels like.