By Jim Krane and Michael Maher
U.S. shale producers are bracing for the upcoming OPEC meeting as anxiously as their counterparts in Venezuela and Algeria, where low oil prices have also caused economic havoc.
Any sign of a change in the Saudi-driven emphasis on “market share” over prices will be as welcome in Houston as in Caracas.
But U.S. producers are probably looking the wrong way for salvation.
Higher oil prices will indeed be in our future, but the cause is more likely to be closer to home: The huge drop-off in investment in big conventional oil projects outside of the Middle East. Less likely is a Saudi-led clampdown on OPEC production, based on cutting output in the kingdom.
The U.S. shale sector is certainly an important player, and the sharp rise in U.S. oil production has been a key factor in Saudi strategy.
But the Saudis understand that U.S. shale production is flexible and responsive to changes in oil prices. The low barriers to entry and exit allow shale to act as a market-driven swing producer.
As the chart below shows, U.S. oil production is down by almost 500,000 barrels per day from recent highs. When prices rise, crews can truck their rigs back to the oil patch and start drilling and fracking all over again. U.S. shale production can revive in a matter of months.
Therefore, we shouldn’t expect the Saudis to be tying their oil market strategy to the favorite metric of most observers, the U.S. onshore rig count. For them, the key indicator will be the scrubbing of mega-projects in conventional oil, including those of supermajors like
These are multibillion-dollar exploration and production projects that take years to plan and execute. Once they are up and running, they may produce oil for decades. Think of the big investments in the North Sea or in the deep waters of the Gulf of Mexico or off West Africa.
In recent months, there has been a profusion of announced cutbacks. If these deferrals are genuine, it would appear that the seeds of the next oil price spike are now being sown.
Wood Mackenzie has tallied $200 billion in delayed mega-projects containing reserves equivalent to 20 billion barrels of oil. Once deferred, these projects cannot be restarted quickly. In some cases, project teams have been disbanded or even laid off. These include projects in West Africa, Canada, Australia, Indonesia, Norway as well as the U.S. offshore.
Shell’s cancellation of its Arctic drilling campaign is the poster child for this trend, but there are many others.
U.S. major
At the same time, layoffs of nearly 200,000 workers have slashed capabilities of companies in oil services, equipment and supply. This damages their ability to react when oil producers are ready to move. According to Wood Mackenzie, the service sector is capable of handling 40 or more mega projects a year. But it only expects six this year and 10 in 2016.
Houston-based investment bank Tudor Pickering Holt and Co. has identified 150 deferred oil and gas exploration and production projects with a combined resource of 125 billion barrels of oil equivalent that have been deferred in recent months. That equates to $125 billion in lost capital expenditures over the next five years.
Unsurprisingly, the big losers TPH identifies are the expensive and politically risky projects.
The biggest, in terms of resource and production are those in the vast Canadian oil sands, where energy-intense methods are used to extract and convert hard bitumen into liquid that can flow through a pipeline. The International Energy Agency estimates oil sands producers need $95 to $114 per barrel to make new investments work.
Norway is another loser, with its pricey deepwater projects in sub-Arctic waters. There has also been dwindling interest in Iraq, given problems with unrest, unpaid invoices, and questionable sovereignty over natural resources.
It is not just oil projects. TPH says deferrals include some 20 expensive LNG projects accounting for 20 billion cubic feet/day. The biggest are in Canada, Australia and Mozambique.
A third of the abandoned projects are operated by supermajors, with BP and Chevron topping the list. ExxonMobil’s deferrals could remove the most oil from markets. Least affected is France’s Total, which had fewer projects in the planning stage.
OPEC itself is not immune to low oil prices. The cartel forecasts that its members will fund half as many projects over the next four years, compared to levels reached in 2014.
The IEA and others have warned that there will be a price paid for short-sighted investment cutbacks, and consumers will be called upon to bear it. Individual decisions to cut capital spending can have big aggregate effects on prices when markets tighten. And with global oil demand rising, that is just a matter of time.
When high oil prices return, these cancelled projects may suddenly look viable. But, as we have seen during past boom and bust cycles – including the high prices of the last decade – restarting project development can take years. Prices move quickly. New conventional oil production does not.
When oil prices jump, shale producers are the only suppliers outside the Middle East that can respond quickly. But shale is a U.S. phenomenon. Its output is too small to cover deferred production from major conventional projects, let alone a big oil outage or demand spike. And anyhow, shale will be of marginal use if U.S. producers remained banned from exporting crude oil.
Thus shale is a given. The Saudis understand that American shale oil is viable at a certain price. Their market models are now undoubtedly factoring in shale’s return.
That is probably why the current Saudi strategy is so unrelenting. The Saudis need lots of pain in oil markets; pain that goes beyond what is sufficient to drive down shale production. The Saudis need to drive out – or delay – big conventional oil projects too, since that is where much of their future competition lies.
For the rest of us, investment deferrals raise the specter of another round of volatile swings in oil prices in coming years. While U.S. shale will be an important asset in helping us cope in the coming years, it is too small to do it alone.
Jim Krane is the Wallace S. Wilson Fellow for Energy Studies at Rice University’s Baker Institute for Public Policy. Follow him on Twitter on @jimkrane
Michael Maher is the Senior Program Advisor at Rice University’s Baker Institute. Follow him on Twitter on @MichaeMaher200A
