The party is over for US shale (or Light Tight Oil “LTO”), so say some very smart and well researched analyses (here and here). 

The party has only just started – and LTO could provide energy independence and even energy dominance for the US for years to come (source:every mainstream press article..).

Cheap Oil underpins growth and development, expensive oil will likely tilt us into a global recession, where the debt-berg will sink many a Titanic. How can something so politically significant be so differently understood? 

It’s not as if the data on the LTO isn’t there; the US oil patch is operated by many public companies and regulated by state and federal bodies who publish huge amounts of data, not to mention the industry itself publishing vast data.

How can we not know?


The world uses 100,000,000 barrels of oil every day or 36.5 billion barrels every year.  These are very big numbers. The trade in oil dwarfs all metals combined in value.  One hundred million barrels a day at $60/bbl is an annual flow of capital of $2,200,000,000,000 dollars. Every $10 increase in the price per barrel is another $365 billion annually. The balance of power between producers and consumers ebbs and flows as the tides. Whilst denominated in US dollars, the US dollar can remain unpegged by gold or any other basis of fiat, as energy is the economy.

As I have tried to describe previously, the price of oil feeds through into almost every aspect of modern life, and can quickly lead to inflation in the “cost of living” which leads to social unrest.  It has been shown how spikes in the oil price (and/or strength of the USD) are strongly correlated, and likely cause, major recessions. So, given this, as well as the vast sums the financial markets move on top of the physical markets, it is little wonder that a lot of smart people spend a lot of time crystal-ball gazing trying to forecast the oil price. For anyone who has tried, it quickly becomes apparent that logic only applies for brief periods and that incomplete data, geopolitical whims and black-swan events are in fact the norm.

That being said, whilst there are innumerable variables that influence the price of oil, it is really down to two drivers:

  1. the demand/supply balance, and
  2. the view of how that balance will play out in the immediate future. 

Critical to the second point is the concept of surplus supply capacity. When the perception is that there is adequate surplus supply capacity, we live in a world of complacency; when the view is of limited surplus, panic sets it and prices spike.

A brief history of surplus supply

When Saudi Arabia and OPEC cut production to push prices up in the 1970s as a reaction to geopolitical events, Saudi Arabia alone cut production from 10mmbbls/day to 2mmbbls/day. This was a politically-engineered and abrupt change in the surplus supply capacity. There was limited spare capacity available elsewhere to replace this crude shortfall, and prices tripled.  However, as is now well known, the market reacts to such dislocations. Demand, whilst only semi-elastic, reacted with changes in behaviour and substitution (Anecdotally, the seemingly bizarre US speed restrictions of 55 mph on vast, straight and empty interstate highways was imposed at this time as an energy efficiency measure – the energy consumption is exponentially related to speed, although fuel consumption is related to speed by a more complex and less punitive function). 

On the supply side, new sources of crude were found (North Sea, Alaska etc). Once the situation had rebalanced, and the scale of the new production had become apparent, OPEC realized that they had created a monster which was characterized by reduced market share and falling prices. The price of oil stayed low from the mid 1980s through to the mid 2000s, mainly because everyone “knew” there was a lot of surplus capacity, even as Saudi oil returned to the market.  Only the Commodity Super Cycle (driven by Chinese demand and the era of cheap money), started to really nip at the heels of the surplus.

The “peak-oil” scare of the 2008-2010 was a short-lived era of perceived supply shortage. It was essentially predicting low to non-existent surplus supply due to the exhaustion of the massive conventional fields that underpin global production. Probably not wrong in a absolute sense, but the timing remains unknown to this day. In the context of perceived imminent supply collapse (and strong demand), the oil price reacted and (apart from the financial crisis) stayed strong.

Fast-forward to today, and the picture looks very different, with demand possibly faltering on slowing global growth (but read the headlines carefully, “slowing growth” is still growth)and unknown effects of trade wars combined with the perception that US shale (and subsequent extension to other areas of the world) makes us “awash with crude”. Certainly, there is huge volatility in the oil price. This volatility may well be a reflection of two very different points of view which ebb and flow on the tides of news stories.

(1)   The Bull case that “peak shale” is not so far off, and that we are actually potentially short of mid-grade crude. The thesis is that the investment hiatus in conventional production in 2014-2019 will come back to bite as the lack of Capex translates into increasing underlying decline rates and longer-dated new projects, and shale won’t be able to fill the gap.

(2)   The Bear case that the US Shale has fundamentally changed the supply side – with “drowning in oil” being the vivid imagery used in the mainstream press, and projections of US Shale (excluding conventional GOM and onshore production) doing 20mmbbls/d by 2025.

If you can measure it, you can manage it.

I will try and put some flesh on the bones of these two points-of-view in the subsequent paragraphs, but the question I am asking here is: given that the US production comes from public companies with reporting requirements, and that there is a huge amount of publicly available data on a well-by-well basis, how come the opposing points of view can by so far apart? Plus or minus $15mmbbls/day within 6 years, will radically alter the course of the world economy.  How can we not know?

The Bull Case:

Russia, Saudi Arabia and USA combined produce 33% of the world’s oil and essentially all the swing production. Russia has benefitted from high margins as even low oil prices over the last few years have been offset by even lower costs as the Rouble has devalued (including as a direct result of US Sanctions on the Kremlin-business nexus).  Russian production is higher now than at any time since the break-up of the Soviet Union.

Saudi production/reserves have always been and remain a big “Known Unknown”. The production is clearly at or about 11.x mmbbls/day, but there is a huge uncertainty on the future.  Between 5 and 6 of these 11mmbbls/day come form the Ghawar field, which is the largest known oil field in the world, but is old and in advanced secondary recovery.

Saudi Aramco has always kept a tight veil of secrecy over its data, but a historical view would seem to suggest that there is not much spare capacity. In the above, when Saudi produces below 10mmbopd (the blue and below) one can understand the market’s view that there is unused capacity that can be brought on if the right tweet is sent. However, when in the red, it is harder to understand that there is easily available spare capacity.

As we are frequently reminded, the US is likewise producing more than ever in its history. Not the subject for today, but it is also worth noting that LTO is “light” and sweet, and that the injection of huge amounts of this crude into the world market is upsetting the balance not just in terms of volumes but also in terms of grade/quality. Not all crude is equal.

 Outside of the Big Three, we can see many smaller producers having difficulty with declining production. Usually a combination of declining legacy fields, underinvestment, as well as political barriers to investment – Indonesia, Venezuela, Mexico and Angola come to mind.

Production in Mexico is declining at about 7% p.a. The opening of the country to investment has been relatively successful albeit small-scale and exploration driven. But even this is now being reversed.

But the chief executive of one energy company scoffed: “It wouldn’t matter if they invested 10 trillion pesos in Pemex, it’s not going to happen,” (FT)

It is clear that Big Oil has been under investing in the downturn; but NOCs will be worse because their budgets are used primarily for state support and only secondarily for oil field expenditure. Big Oil produces around 12-15% of the world’s production, so the vast majority is likely being underinvested. Global annual decline being 6% not 4% has a massive cumulative effect on a future supply shock.

So if we accept the unknowns on declines, Saudi spare capacity and evolution of demand one huge variable stands out – US production, is Peak Shale around the corner, or is there “no constraint” to US shale getting to 20 mmbbls/day ? 

The Bear Case:

At the WECA conference in London in December, Rystad Energy gave a presentation in which two things stood out. (1) Rystad Energy predictions of the shale over the last few years had been generally more bullish than most observers yet were systematically underestimating the actual production and (2) that they project supply getting to $20mmbbls/d by 2025 with– “no obvious barriers to achieving this”.  Now I take that with a pinch of salt, as it ignores the economics – but nevertheless, if the potential really is that great, and the US is nothing if not efficient, then it should be on everyone’s radar.

I don’t know how this forecast was calculated, but it seems like a geo-spatial extrapolation from known data on geology, development areas and production, into undeveloped areas. Nothing wrong with that per se, but as noted above, it probably ignores the economics and logistics.

There is clearly no shortage of oil in the ground; the press often refers to the resource plays of the US shale as “fields” – these are not fields these are massive source-rocks that are being tapped, and its not just the US. The Vaca Muerta in Argentina is reported to be 3x the Permian. Oil in the ground is not the issue. Getting the oil out, and getting it out at a price that works is the issue. I’ll repeat that.

Getting the oil out, and getting it out at a price that works is the issue.

Big Oil is moving in and industrializing the process, but in reality, this will be a trade-off between the economies of scale that Big Oil can bring versus the overheads that they also carry with them. Certainly one to watch, but unlikely to be cheap oil.

The Big Unknown.

The big unknown here really is the later-life or “legacy” decline rate. Most people are aware that these wells drop 60-70% in the first year, and in the region of 30% in the second. This is typically modelled a hyperbolic decline curve. The great unknown is what happens when wells get to their mid- and late-life.  (note that time is right-to-left in this image) If you really want to geek out, this article and its long comments section is fun.

Will they keep producing a few tens of bbls/day with declines reducing to single figures, or will they decay to sub-economic production faster?  Is the tail of the curve tangential or reducing to zero? In the former case a huge stack of legacy wells, all producing a bit, but cumulatively producing a cash-flow lifeline, could underpin the financials of companies as they continue to chase their tails with new wells.

The [Eagleford] basin is aging rather rapidly, and in September almost 80% of these horizontal wells were producing below 50 bo/d

This appears to have happened in the more mature gas plays of the Marcellus, but gas and oil may behave differently.  The US has a vast array of “stripper” wells that do a few bopd. These can essentially be turned on (pumped) when the price is high enough and shut when not. However, there is a significant difference between a 1,500ft vertcal stripper well and a 15,000ft multi-lateral horizontal fracced shale well. I doubt the economics are the same at all in late life.

The US shale is however, incredibly data rich – yet we have massively contrasting views, based on available data… this is odd. Maybe the problem is not the lack of published data, but the newness of the whole system. The lack of data is the lack of historical data on the behaviour of the late-life production. A bit like the apocryphal comment attributed to Mao concerning the French Revolution: maybe its just too soon to judge!

The Conspiracy Theory

The alternative explanation is that the US is deliberately funding shale production, in full, but well hidden, knowledge that it is sub-economic. The logic is that billions of dollars of subsidies through written-off investments is small change when compared to the trillions of dollars spend in fighting wars in Iraq, Afghanistan and Syria. Energy Independence allows for disengagement in the Middle East.  As with all good conspiracy theories there is some logic and some facts that can be pointed to (recent troop withdrawal announcements etc). Overall, I don’t buy into this as it would require that the US finance industry is in fact directed by government policy, and collectively comfortable with losing money for the greater good. Unlikely in the home of free market capitalism. Notwithstanding this, a lot of money is being lost. More likely is that everyone is making money and assuming it will be “the other guy” who loses his (or her) shirt when the music stops.

The economics of the shale is a tempting topic for my next post.

Known Unknown

There is a growing realization that the “energy transition” is not going to happen overnight and that in-the-meantime, we actually need fossil fuels to maintain the status quo of the industrial-technological societies in which we live. The reason for this is that fossil-fuels provide huge “bang for your buck” (or EROEI), and are in many ways stupidly cheap.

Like it or not, cheap energy is the foundation of everything we have. Without it we’d all be growing potatoes in the garden.  If you are not sure, read some novels by Dickens of Hugo; it wasn’t that long ago.  Oil, and specifically the price of oil is a key driver for the world’s economy. 

In the presence of so much data, how can we not know?

I would love to hear your views on whether the Shale party is winding down, or just getting started… My view? It is just a function of price.