- December 19, 2018
- Posted by: Art Berman
- Category: The Petroleum Truth Report
The Wall Street Journal’s recent editorial “How America Broke OPEC” shows that even high-quality journalism is susceptible to the contagion of alternative facts.
It is a propaganda piece about how the underdog U.S. oil industry miraculously rose from the ashes and kicked OPEC’s ass.
Never mind that the U.S. has been an oil super power super forever so the premise of the editorial is bogus to begin with.
How Can U.S. Oil “Win” If It’s Broke?
More importantly, how is it possible that the business-focused Wall Street Journal failed to mention that American tight oil—the object of its praise—is broke?
U.S. tight oil lost money in the 3rd quarter of 2018 (Figure 1). Capital expenses have exceeded cash from operations in almost every quarter for the last decade.
That includes the Permian basin darling companies Diamondback, Concho and Pioneer.
There are reasonable arguments that cash flow is always negative during field development. The reality, however, is that tight oil plays are in perpetual field development because of high decline rates. That’s a big part of why most companies never make any money.
It also spoils the story about kicking OPEC’s ass.
Wells Produce Oil, Not Rigs
The Wall Street Journal confuses tight oil production growth with economic success.
“U.S. crude production has surged 20% in a year and nearly tripled in a decade thanks to advances in hydraulic fracturing and horizontal drilling. American output is rising at the fastest rate in a century. Earlier this year the U.S. eclipsed Saudi Arabia and Russia as the world’s largest oil producer.”
How dumb is it to increase oil production when you are losing money on every added barrel?
The Journal then trots out a sad attempt at proof of its impossible thesis (my Figure 2 below). It shows that rigs are becoming more efficient and that more oil per rig is produced as a result.
Think about that last sentence and look at their graph again—production per rig?
Rigs don’t produce oil. Wells do. This is nonsense!
The number of tight oil wells reaches new records every month as average well output decreases.
Giving the Journal a more-than-generous benefit of doubt about their chart, if more efficient rigs don’t result in positive cash flow for the oil companies, why is this chart even relevant?
What Oil Price War?
The Wall Street Journal doesn’t support or even re-state its lascivious headline “How America Broke OPEC” because it isn’t true.
OPEC produces more than 40% of the world’s crude oil and condensate. If anyone doubts OPEC’s power and influence, look up how many articles The Wall Street Journal has written about it over the past year.
The Journal subscribes to the unfounded but widely accepted belief that OPEC has a strategy that involves a price war with U.S. tight oil producers.
“In late 2014, OPEC flooded the market with oil in an effort to break U.S. drillers who were burning cash on mounds of debt.”
The part about cash and debt is true—then and now. The rest is simply untrue.
U.S. and Canadian—not OPEC—production flooded the market in 2014 and caused oil prices to collapse (Figure 3).
OPEC did not respond with increased output until the 2nd quarter of 2015, after Brent prices had fallen from $112 to $48 per barrel.
If anyone started a price war—and I don’t accept that there ever was one—data points toward the U.S. and Canada—not OPEC. OPEC was merely responding to a market-share challenge as any reasonable business would and it showed considerable restraint before taking action.
Another untrue part of the price-war narrative is that OPEC caused oil prices to collapse by deciding not to cut production in late 2014. Wait, didn’t I just show that prices collapsed because of over-production by the U.S. and Canada? Facts often spoil an otherwise good story.
OPEC’s decision not to cut production had little or nothing to do with unconventional oil. It reflected an unwillingness to repeat its mistake of cutting 14 million barrels per day between 1980 and 1985 with little effect on prices while decreasing OPEC market share.
Ali Al-Naimi, the former Saudi oil minister said about the decision not to cut production in 2014, “We met with non-OPEC producers, we asked ‘what are you going to do?’ They said nothing. We said the meeting is over.”
“Non-OPEC producers” means Russia. When Russia changed its mind in late 2016, production cuts occurred and world oil prices began to normalize.
In an interview in 2016, Al-Naimi said, “It would have been stupid of Saudi Arabia to agree to a cut then [in 2014]. More non-OPEC production would have come [on the markets]. We had no choice.”
Stick to Politics, Not Oil
Oil markets are complicated. I have been trying to understand them for more than 40 years and can only claim partial success. The Wall Street Journal, along with many analysts and politicians, thinks it is has all the answers in its kit bag of American exceptionalism and alternative facts.
The sheik vs shale narrative reflects an immature perspective that sees oil markets in simplistic terms of winners and losers. It fundamentally disrespects the intelligence of OPEC. Attention to data and history should at least cast doubt on the narrative’s validity.
I am no apologist for OPEC but I am an advocate for facts.
There are many things to praise about the U.S. oil industry. Making money in tight oil plays is not among them.
The Wall Street Journal generally writes fine editorials.”How America Broke OPEC” is not among them.
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I have no positions in oil and gas other than minor equity holdings in two U.S. public companies that are professionally managed with my consent and agreement. I do not consult for any company mentioned in this post.
Thanks Art – great analysis as usual.
While not disagreeing with any of your conclusions, is it not a bit unfair to use ‘cash flow’ as a proxy for profitability when production has been significantly increasing. It would be a fair proxy if production was at steady-state, but it hasn’t been – it’s been rising. That means negative free cash flow includes both maintenance AND expansionary capex. In theory at least that would mean the sector could be profitable although being FCF negative.
Again, not trying to argue the shale patch is hugely profitable.
I understand that you are not disagreeing with me and agree it is impossible to assess maintenance costs & cash flows with increasing production.
Problem is that production won’t flatten with tight oil but would fall 20-30% per year. Share holders would flee, stock price would plummet and companies would fail.
So, have to use what we have. What we have is a decade of negative cash flow. Try to explain it any way we like but it doesn’t have a good ending. Proved reserves don’t suggest we’re just getting started with plays.
Thanks for your comments!
The big Shale companies must act now to stop a complete and total Shale melt down. Why on earth Pump more oil at a loss when the demand isn’t there ? Ridiculous Strategy and It will be their downfall along with all the spent investment, Jobs and afterwards ultimately rocketing oil prices !
Because that’s what they do. Tight oil must have production growth to get money to fund more drilling. Until investors stop the capital flow, this will continue. It’s a good strategy if your focus is executive compensation.
Matt,
You make a good point about distinction between production and exports. Price, however, is formed by a system dynamics response to a universe of inputs and feedback loops.
The graph below is a variant on one that I put in my post. It reflects the rig count response to higher oil prices in 2018 and indicates what is locked into the market’s perception of supply.
Traders find no reason to pay more than $45 or $50 for WTI based on this information until no one will sell. Then, the price will increase.
All the best,
Art
In a world full of fake news propaganda being pushed by big media, it is oh so refreshing to see information that is so much more truthful and non-biased. Thank you for all that you do Art. May you and yours have a very merry Christmas and happy new year! Wishing the best!
Many thanks, Stephen and same to you and your family!
Art
Art,
What’s the Wall Street’s rationale to keep funding the fracking industry? They know the money will never be paid back and even the regular payments are at risk. It’s as if they’re hoping for the funding to grow big enough to become a systemic risk so eventually they can be bailed out.
It’s a good question that I have asked for more than a decade.
Until recently, near-zero interest rate margin hunting was a reasonable explanation. That argument is less compelling at current rates and treasury yields but still probably a factor.
Mostly, I think it is because oil is the master resource and smart investors see through the delusion of the tight oil promise of abundant oil for decades. I also think they doubt that peak demand or transition to renewable energy will be as soon or as complete as many hope.
It sells newspapers because that is what people want to hear.
Excellent words of wisdom, once again. Thanks Art. Your forecast for CI and resulting oil prices by 2019-end would be much appreciated.
I expect 2019 prices to average around $60 WTI. That may be wrong but that’s my best, educated guess based on what I know right now.
So, shale wells have high depletion rates and shale well oil production has been increasing. That implies to me that reserve replacement has to hit a wall at some point. Then, all the effort will then be drilling and drilling just to replace reserves so they can produce the same as last week/month/year. If this is true then, a point must come soon after where drilling and drilling will produce less and less oil. How can that ever be profitable? Who is investing in this? Shale oil seems prime for utter collapse. And not a slow gradual taper with thousands of stripper wells. The massive debt ponzi scheme will make sure of that. If oil isn’t profitable to produce????
Hellow Art
Certain journalistic notes appeared in Argentina say the development cost of the wells that operate in the Neuquén formation of Vaca Muerta, at US $ 10 a barrel equivalent of oil due to efficiency improvements
I know Arabia Saudita can have these price, but it is posible in Vaca Muerta
I alwas read your web and If I were a millionaire I would invite him to give presentations in Argentina
best regards
Carlos,
Those costs are absurd. You should always ask, What costs are excluded to arrive at such a preposterous value?
Basic operating costs for shale plays in the United States are $13-$15/barrel. No one disputes those costs. This does not include capital expenditures so it is development cost as long as there are no well repairs, etc.
All the best,
Art
[…] Art Berman keeps telling us that shale oil is an expensive resource that could be produced at a profit only for market conditions that are unrealistic to expect. So far, much more money has been poured into shale oil production than it has returned from the sales of shale oil. “Energy dominance” seems to be just an elaborate way to lose money and resources. Again, what sense does that make? […]
Estimado Art
I was the person that ask abaut low price of Oil in Vaca Muerta
And I aw tha If I could I like Invite you to Argentina to explain the reality of Oil
Best Regads
Carlos,
I would love to return to Argentina! We only have to find a way to pay for it!
All the best,
Art