- January 5, 2015
- Posted by: Art Berman
- Category: The Petroleum Truth Report
OP: What, if any, effect will low oil prices have on the US oil exports debate?
Arthur Berman: The debate about U.S. oil exports is silly. We produce about 8.5 million barrels of crude oil per day. We import about 6.5 million barrels of crude oil per day although we have been importing less every year. That starts to change in 2015 and after 2018 our imports will start to rise again according to EIA. The same thing is true about domestic production. In 2014, we will see the greatest annual rate of increase in production. In 2015, the rate of increase starts to slow down and production will decline after 2019 again according to EIA.
Why would we want to export oil when we will probably never import less than 37 or 38 percent (5.8 million barrels per day) of our consumption? For money, of course!
Remember, all of the calls for export began when oil prices were high. WTI was around $100/barrel from February through mid-August of this year. Brent was $6 or $7 higher. WTI was lower than Brent because the shale players had over-produced oil, like they did earlier with gas, and lowered the domestic price.
U.S. refineries can’t handle the light oil and condensate from the shale plays so it has to be blended with heavier imported crudes and exported as refined products. Domestic producers could make more money faster if they could just export the light oil without going to all of the trouble to blend and refine it.
This, by the way, is the heart of the Keystone XL pipeline debate. We’re not planning to use the oil domestically but will blend that heavy oil with condensate from shale plays, refine it and export petroleum products. Keystone is about feedstock.
Would exporting unrefined light oil and condensate be good for the country? There may be some net economic benefit but it doesn’t seem smart for us to run through our domestic supply as fast as possible just so that some oil companies can make more money.
OP: In global terms, what do you think developing producer nations can learn from the US shale boom?
Arthur Berman: The biggest take-away about the U.S. shale boom for other countries is that prices have to be high and stay high for the plays to work. Another important message is that drilling can never stop once it begins because decline rates are high. Finally, no matter how big the play is, only about 10-15% of it—the core or sweet spot—has any chance of being commercial. If you don’t know how to identify the core early on, the play will probably fail.
Not all shale plays work. Only marine shales that are known oil source rocks seem to work based on empirical evidence from U.S. plays. Source rock quality and source maturity are the next big filter. Total organic carbon (TOC) has to be at least 2% by weight in a fairly thick sequence of shale. Vitrinite reflectance (Ro) needs to be 1.1 or higher.
If your shale doesn’t meet these threshold criteria, it probably won’t be commercial. Even if it does meet them, it may not work. There is a lot more uncertainty about shale plays than most people think.
OP: Given technological advances in both the onshore and offshore sectors which greatly increase production, how likely is it that oil will stay below $80 for years to come?
Arthur Berman: First of all, I’m not sure that the premise of the question is correct. Who said that technology is responsible for increasing production? Higher price has led to drilling more wells. That has increased production. It’s true that many of these wells were drilled using advances in technology like horizontal drilling and hydraulic fracturing but these weren’t free. Has the unit cost of a barrel of oil gas gone down in recent years? No, it has gone up. That’s why the price of oil is such a big deal right now.
Domestic oil prices were below about $30/barrel until 2004 and companies made enough money to stay in business. WTI averaged about $97/barrel from 2011 until August of 2014. That’s when we saw the tight oil boom. I would say that technology followed price and that price was the driver. Now that prices are low, all the technology in the world won’t stop falling production.
Many people think that the resurgence of U.S. oil production shows that Peak Oil was wrong. Peak oil doesn’t mean that we are running out of oil. It simply means that once conventional oil production begins to decline, future supply will have to come from more difficult sources that will be more expensive or of lower quality or both. This means production from deep water, shale and heavy oil. It seems to me that Peak Oil predictions are right on track.
Technology will not reduce the break-even price of oil. The cost of technology requires high oil prices. The companies involved in these plays never stop singing the praises of their increasing efficiency through technology—this has been a constant litany since about 2007—but we never see those improvements reflected in their financial statements. I don’t doubt that the companies learn and get better at things like drilling time but other costs must be increasing to explain the continued negative cash flow and high debt of most of these companies.
The price of oil will recover. Opinions that it will remain low for a long time do not take into account that all producers need about $100/barrel. The big exporting nations need this price to balance their fiscal budgets. The deep-water, shale and heavy oil producers need $100 oil to make a small profit on their expensive projects. If oil price stays at $80 or lower, only conventional producers will be able to stay in business by ignoring the cost of social overhead to support their regimes. If this happens, global supply will fall and the price will increase above $80/barrel. Only a global economic collapse would permit low oil prices to persist for very long.
OP: How do you see the global energy mix changing in the coming decades? Have renewables made enough advances to properly compete with fossil fuels or is that still a long way off?
Arthur Berman: The global energy mix will move increasingly to natural gas and more slowly to renewable energy. Global conventional oil production peaked in 2005-2008. U.S. shale gas production will peak in the next 5 to 7 years but Russia, Iran, Qatar and Turkmenistan have sufficient conventional gas reserves to supply Europe and Asia for several decades. Huge discoveries have been made in the greater Indian Ocean region—Madagascar, offshore India, the Northwest Shelf of Australia and Papua New Guinea. These will provide the world with natural gas for several more decades. Other large finds have been made in the eastern Mediterranean.
There will be challenges as we move from an era of oil- to an era of gas-dominated energy supply. The most serious will be in the transport sector where we are thoroughly reliant on liquid fuels today —mostly gasoline and diesel. Part of the transformation will be electric transport using natural gas to generate the power. Increasingly, LNG will be a factor especially in regions that lack indigenous gas supply or where that supply will be depleted in the medium term and no alternative pipeline supply is available like in North America.
Of course, natural gas and renewable energy go hand-in-hand. Since renewable energy—primarily solar and wind—are intermittent, natural gas backup or base-load is necessary. I think that extreme views on either side of the renewable energy issue will have to moderate. On the one hand, renewable advocates are unrealistic about how quickly and easily the world can get off of fossil fuels. On the other hand, fossil fuel advocates ignore the fact that government is already on board with renewables and that, despite the economic issues that they raise, renewables are going to move forward albeit at considerable cost.
Time is rarely considered adequately. Renewable energy accounts for a little more than 2% of U.S. total energy consumption. No matter how much people want to replace fossil fuel with renewable energy, we cannot go from 2% to 20% or 30% in less than a decade no matter how aggressively we support or even mandate its use. In order to get to 50% or more of primary energy supply from renewable sources it will take decades.
I appreciate the urgency felt by those concerned with climate change. I think, however, that those who advocate a more-or-less immediate abandonment of fossil fuels fail to understand how a rapid transition might affect the quality of life and the global economy. Much of the climate change debate has centered on who is to blame for the problem. Little attention has been given to what comes next namely, how will we make that change without extreme economic and social dislocation?
I am not a climate scientist and, therefore, do not get involved in the technical debate. I suggest, however, that those who advocate decisive action in the near term think seriously about how natural gas and nuclear power can make the change they seek more palatable.
The great opportunity for renewable energy lies in electricity storage technology. At present, we are stuck with intermittent power and little effort has gone into figuring out ways to store the energy that wind and solar sources produce when conditions are right. If we put enough capital into storage capability, that can change everything.
By James Stafford of Oilprice.com
With US oil and gas rigs down another 29 this week, at what point does production begin to decline? It seems that producers are moving rigs toward sweet spots which may increase production while also reducing total rig numbers. This should also decrease the time to peak production which is a topic that is never mentioned by msm.
I don’t agree with your financial analysis of Continental.
To determine the FCF you distract the replacement investments from the operational cash flow, not the entire capital expenditures.
But we cannot distinguish the kind of investment easily and some alternative ways of calculus is needed.
According to my template the break-even price for the year 2013 was around $65 dor CLR. But the weird thing is that this price seems to rise over the years.
Romandiére, The way that I have determined free cash flow is the standard approach. I have published these methods many times and you are the first to disagree. Your way may be more meaningful but it is not knowable from financial statements.
I think that subtracting capex from cash from operating activities is a meaningful index of profitability whether or not you agree that it provides free cash flow. If the company is spending more than it is making, that is not profitable. The classic argument is that the profits will come down the road after all of the development capex is finished but with shale plays, the drilling never stops nor does it slow down. So, if you are not making money yet, it is unlikely that will change in the future.
Thanks for your comments.
You can’t use rig counts to determine drilling activity because so much drilling is done from pads–one rig drills many wells. Look at the number of producing wells vs production and you will see that there are as many new producing wells in most active plays as there ever were in the past.
Arthur, thank you for your reply.
I do understand your pov but I’m not the guy who accepts easily that this formula is all I can rely on.
Some creativity allows us to make an educated guess. Personally I started from the idea that the change in proved developed reserves represented capex that should not be substracted from the FCF, as it represents future production.
All kinds of ratio’s and observations of the dynamics over many years and across competitors, can give us some insight.
Though it is a tough job.
And I have not written that I do not agree with you on the final issue. Even in my model the shareholders will not receive a return in the future ($65 in 2013 is without repayment of the shareholders and without return).
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