The Real Cause Of Low Oil Prices: Interview With Arthur Berman
With all the conspiracy theories surrounding OPEC's November decision not cut production, is it really not just a case of simple economics? The U.S. shale boom has seen huge hype but the numbers speak for themselves and such overflowing optimism may have been unwarranted. When discussing harsh truths in energy, no sector is in greater need of a reality check than renewable energy.
In a third exclusive interview with James Stafford of Oilprice.com, energy expert Arthur Berman explores:
• How the oil price situation came about and what was really behind OPEC's decision
• What the future really holds in store for U.S. shale
• Why the U.S. oil exports debate is nonsensical for many reasons
• What lessons can be learnt from the U.S. shale boom
• Why technology doesn't have as much of an influence on oil prices as you might think
• How the global energy mix is likely to change but not in the way many might have hoped
OP: The Current Oil Situation - What is your assessment?
Arthur Berman: The current situation with oil price is really very simple. Demand is down because of a high price for too long. Supply is up because of U.S. shale oil and the return of Libya's production. Decreased demand and increased supply equals low price.
As far as Saudi Arabia and its motives, that is very simple also. The Saudis are good at money and arithmetic. Faced with the painful choice of losing money maintaining current production at $60/barrel or taking 2 million barrels per day off the market and losing much more money—it's an easy choice: take the path that is less painful. If there are secondary reasons like hurting U.S. tight oil producers or hurting Iran and Russia, that's great, but it's really just about the money.
Saudi Arabia met with Russia before the November OPEC meeting and proposed that if Russia cut production, Saudi Arabia would also cut and get Kuwait and the Emirates at least to cut with it. Russia said, "No," so Saudi Arabia said, "Fine, maybe you will change your mind in six months." I think that Russia and maybe Iran, Venezuela, Nigeria and Angola will change their minds by the next OPEC meeting in June.
We've seen several announcements by U.S. companies that they will spend less money drilling tight oil in the Bakken and Eagle Ford Shale Plays and in the Permian Basin in 2015. That's great but it will take a while before we see decreased production. In fact, it is more likely that production will increase before it decreases. That's because it takes time to finish the drilling that's started, do less drilling in 2015 and finally see a drop in production. Eventually though, U.S. tight oil production will decrease. About that time—perhaps near the end of 2015—world oil prices will recover somewhat due to OPEC and Russian cuts after June and increased demand because of lower oil price. Then, U.S. companies will drill more in 2016.
OP: How do you see the shale landscape changing in the U.S. given the current oil price slump?
Arthur Berman: We've read a lot of silly articles since oil prices started falling about how U.S. shale plays can break-even at whatever the latest, lowest price of oil happens to be. Doesn't anyone realize that the investment banks that do the research behind these articles have a vested interest in making people believe that the companies they've put billions of dollars into won't go broke because prices have fallen? This is total propaganda.
We've done real work to determine the EUR (estimated ultimate recovery) of all the wells in the core of the Bakken Shale play, for example. It's about 450,000 barrels of oil equivalent per well counting gas. When we take the costs and realized oil and gas prices that the companies involved provide to the Securities and Exchange Commission in their 10-Qs, we get a break-even WTI price of $80-85/barrel. Bakken economics are at least as good or better than the Eagle Ford and Permian so this is a fairly representative price range for break-even oil prices.
But smart people don't invest in things that break-even. I mean, why should I take a risk to make no money on an energy company when I can invest in a variable annuity or a REIT that has almost no risk that will pay me a reasonable margin?
Oil prices need to be around $90 to attract investment capital. So, are companies OK at current oil prices? Hell no! They are dying at these prices. That's the truth based on real data. The crap that we read that companies are fine at $60/barrel is just that. They get to those prices by excluding important costs like everything except drilling and completion. Why does anyone believe this stuff?
If you somehow don't believe or understand EURs and 10-Qs, just get on Google Finance and look at third quarter financial data for the companies that say they are doing fine at low oil prices.
Continental Resources is the biggest player in the Bakken. Their free cash flow—cash from operating activities minus capital expenditures—was -$1.1 billion in the third- quarter of 2014. That means that they spent more than $1 billion more than they made. Their debt was 120% of equity. That means that if they sold everything they own, they couldn't pay off all their debt. That was at $93 oil prices.
And they say that they will be fine at $60 oil prices? Are you kidding? People need to wake up and click on Google Finance to see that I am right. Capital costs, by the way, don't begin to reflect all of their costs like overhead, debt service, taxes, or operating costs so the true situation is really a lot worse.
So, how do I see the shale landscape changing in the U.S. given the current oil price slump? It was pretty awful before the price slump so it can only get worse. The real question is "when will people stop giving these companies money?" When the drilling slows down and production drops—which won't happen until at least mid-2016—we will see the truth about the U.S. shale plays. They only work at high oil prices. Period.
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