On Tuesday the Winston & Strawn law firm rented out the main hall of Houston's River Oaks Country Club and brought in some smart guys to provide perspective for a cocktail-hour discussion on the topic: U.S. Energy Outlook. The panel consisted of T. Boone Pickens, former Houston Mayor Bill White and Dan Pickering of investment banking firm Tudor, Pickering & Holt.
Their consensus: the U.S. energy outlook is great. Really fracking great. And that means great things for the rest of the U.S. economy as well -- as long as oil prices don't get too low.
It's not news that America is undergoing an oil and gas boom. Or that the boom has been brought to us by the dedicated efforts of dozens of independent oil companies working to perfect the one-two punch of horizontal drilling and hydraulic fracturing.
What is news is that the boom is showing no signs of slowing down. Ten years into the shale drilling revolution, oil and gas companies have proven that this is "the real deal," says Pickering. And as drilling expands it will continue to be "the next big thing" for another 20 years.
Pickens marveled that despite oil prices surging threefold over the past decade, "The United States is the only place that has added production."
Yes the production growth has been shocking. America's crude oil output first peaked in 1970 at 10 million barrels per day. The nadir was in 2008, when oil hit a record high $147 per barrel amid sadsack U.S. output of 5 million bpd. Since then the surge has been asymptotal, with output topping 8.5 million bpd in June. If oil prices stay strong there is little doubt that we will hit a new record in 2015.
The growth in natural gas output has been just as stunning. This year total gas withdrawals will approach 31 trillion cubic feet, up 32% since 2005.
And yet the reality of this revolution hasn't yet been fully appreciated even by the economists whose job it is to appreciate it. Yesterday Thomas Tunstall at the University of Texas at San Antonio published a report stating his findings that the economic impact of the Eagle Ford shale of south Texas was more than $87 billion in 2013. Just 18 months ago Tunstall had figured that level wouldn't be achieved until 2022.
Pickens in the office. With Murdock. (Photo by Michael Thad Carter for Forbes, January 2014)
Driving those revisions is the realization that with all this oil and gas is coming massive investments in petrochemical plants and pipelines and roads and railroads and housing for workers.
"Capital is mobilizing. Industry is putting a lot of money into the ground," says Bill White, now chairman of the Houston office of Lazard, and former CEO of Houston oil and gas service company Wedge Group. "Now is a good time to be pipeline welder or to be Trinity Industries," which makes new rail cars to carry oil.
Pickering, who got his start working in Alaska for Arco, had a number to put on it: over the next 20 years more than $600 billion will be invested in oil and gas infrastructure like pipelines. And to think that's just a small fraction of what will be spent on drilling and fracking.
So what could go wrong?
Mae West famously said, "Too much of a good thing can be wonderful." While all this oil and gas has been a wonderful boon for post-recession America, could there be such a thing as too much of it?
Boone Pickens thinks so. "We now have too much oil," sighs Pickens. At $93 per barrel this week U.S. crude has fallen $13 per barrel since June. And that price is what you get at trading hubs, not out in the field. "Midland oil [from west Texas] can only fetch $83. That's $10 below the market price. If the price gets below $80 they'll lay some rigs down" and stop drilling.
Why the big discount? Because as fast as they're building pipelines and rail spurs to get the crude out to trading and refining hubs, they're not building fast enough to keep up with the drilling rigs.
Natural gas prices are under pressure too. Six years ago U.S. drillers were running 1,300 gas rigs. Now that's down to 300. "We found too much gas," says Pickens. "2015 is going to be bad for gas," says Pickering, meaning that prices should be heading down from current levels of $4.50 per thousand cubic feet. "You don't make money in $2s. You make a ton of money in the $5s."
Present at the event Tuesday was Gary Evans, CEO of
The average Joe should welcome lower prices for oil and gas, right? After all, cheap energy should spur broader economic growth outside the fracking fields. And soft prices gives the pipeline and petrochem builders some time to catch up, right?
Don't tell that to the oil and gas companies. Tens of billions of dollars in market capitalization is contingent upon oil companies maintaining growth. They have to drill fast enough to hold their acreage before leases expire. At the same time, they have to get their volumes up high enough that they can generate enough free cash flow to pay back their debt. If you can't drill economically it all unravels.
Pickens understands this intimately. In 1996 his Mesa Petroleum had taken on too much debt while betting that the price of natural gas would go high enough to return the company to profitability. It didn't, and in 1997 Pickens had little choice but to sell Mesa to a stronger rival and walk away.
It even happened to his Dad. In 1931 Pickens' Dad had a small oil company. But it went out of business after the discovery of the East Texas oilfield drove the price of oil down to 10 cents a barrel. Dad "couldn't stay alive" because he needed 50 cents a barrel to make money.
No matter what era you're in, when excess oil floods the market it will wipe out the little guy.
Pickens is drilling on his own ranch up in the Texas panhandle. "The sad thing is I'm 86. I'm not gonna see another 20-30 years of this," he says. "I may get 20." The audience laughed.
It is a testament to the power of American oil and gas that prices have softened so much, even in the face of Middle East strife. Libya's oil industry remains in chaos, with rival government arguing over who controls it. Iraq's and Russia's output has been flat. Iran is down to 3 million bpd from 3.7 mm in 2012.
If the U.S. were not adding so many barrels, "oil would be sky high," says White. That said, anything could happen, he says. "If anyone thinks they know oil 5 years out they're a crank."
Indeed a lot could happen in five years. In 2009 absolutely no one predicted the growth in U.S. oil supply. So what will happen between now and 2019? Should American drillers, already worried about oil prices slipping below their marginal costs, worry too about competition from shale drilling in the rest of the world?
Eh, not so much.
"There's going to be shale plays developed in other parts of the world, but we've got a big headstart," says White. We already have pipelines, rigs, a trained workforce, and tons of mental capital.
To a large extent these factors are more important than having amazing geology because they dramatically reduce upfront costs. Argentina, for instance, has world-class shale formations, but the politics muddies the waters.
And then, says Pickens, there's perhaps the biggest factor in America's favor: private ownership of mineral rights. America is virtually unique in the world in that private landowners, rather than the state, hold title to the oil and gas under their acres. With average royalty rates in Texas paying landowners 25% off the top for any oil and gas recovered, that's an enormous incentive for ranchers and farmers to welcome drilling rigs onto their land.
That's not the case in Russia, Mexico, China, the Middle East, and virtually everywhere else -- where the government owns the minerals and farmers have to be coerced into giving access to drillers.
The most striking comments from the panel came in response to a question about whether they believed the oil and gas liberalizations underway in Mexico (i.e. allowing private companies to operate alongside state monopoly Pemex) would succeed in spurring production growth there.
Pickens' answer: "No. It will fail."
Why? First of all, because Pemex in its "Round Zero" licensing phase will already cherrypick the best prospects. Second, because corruption in Mexico's oil sector remains rife. Third, because security costs will be substantial in areas controlled by drug cartels -- that includes the Burgos Basin region between the Rio Grande and Monterrey into which the Eagle Ford extends from Texas.
"Eagle Ford gas production is so much cheaper than in the Burgos Basin," says Bill White. So on pure economic grounds it would make more sense for Mexico to import cheap U.S. gas.
Indeed, with so many opportunities in the U.S., the captains of capital will be thinking: why should I try to reinvent the wheel elsewhere when I can just invest in America?
