http://www.wsj.com/articles/back-to-the-future-oil-replays-1980s-bust-1421196361?mod=e2fb
The discovery of oil from shale rocks means that U.S. output is faster paced. Drilling and hydraulically fracturing a well takes weeks, not years.
Jan. 13, 2015 7:46 p.m. ET
A surge of oil from outside of the Middle East flooded global energy markets. The world-wide thirst for crude didn’t keep up. The Organization of the Petroleum Exporting Countries stood by and watched as oil prices fell and then fell more.
Welcome to the world of oil in 2015—a repeat in surprising ways of the story 30 years ago. Between November 1985 and March 1986, the price of crude plunged by 67%. Between June 2014 and today,
crude prices have fallen by 57% and could well head lower.
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After the mid-1980s bust, it took nearly two decades for oil prices to rebound to pre-bust levels and remain there. Energy executives are now haunted by the question: Will it take as long this time?
The answer may lie in one enormous difference between today and 30 years ago: the speed of shale.
Before U.S. energy companies figured out how to pull oil from shale formations, petroleum projects often took years to execute. Two decades passed between a fisherman spotting a colorful slick floating off the coast of Mexico and oil flowing from the giant Cantarell project off the Yucatan Peninsula. It took nine years and billions of dollars to get crude moving from the North Slope of Alaska to markets.
Today, the discovery and development of oil from shale rocks means that oil output is faster paced and near at hand—in Texas and North Dakota, Colorado, Oklahoma, Wyoming, even Ohio. Drilling and hydraulically fracturing a well takes weeks, not years. An expensive well costs $10 million, compared with the billions needed to drill offshore wells and build associated infrastructure. Moreover, expenditure of both time and money are falling fast.
The oil field investment cycle has shortened. Wildcatters in Texas discovered the Eagle Ford Shale in 2008. Within five years, it was pumping a million barrels a day—thanks to an influx of capital that paid for drilling thousands of new wells. Each well roars into life and then drops off fast. Without constantly drilling new wells, these oil fields will peter out.
Faster-reacting shale production could help cut supply more quickly than in the past, restoring market balance without a decadeslong wait. The availability of so much new oil, housed in easy-to-tap shale formations, could also make price spikes less frequent.
But that doesn’t mean prices will rebound soon, or return to the triple-digit levels seen just months ago. Price pressure may need to remain on the U.S. oil industry and its lenders for months to rein in supply.
Goldman Sachs Group Inc. said Monday it saw a “U-shaped” recovery with depressed prices until the market rebalances and prices rise in 2016. The firm said it expected U.S. crude to average $47.15 a barrel this year, down from a previous prediction of $73.75.
A year of low prices beats a decade, as far as the energy industry is concerned. But it is unclear exactly what will happen: shale-oil output has boomed only in the past five years—and faces its first downturn.
“No one has so far experienced what the actual consequences of a ‘stress test’ on U.S. production could be,” says Leonardo Maugeri, a scholar at Harvard University’s John F. Kennedy School of Government and a former top executive with the Italian oil giant
EniSpA.
Even veteran oil traders are uncertain. “Sustained low prices will ultimately bring the market into balance,” Andrew Hall, who runs a $3 billion energy derivatives hedge fund, Astenbeck Capital Management LLC, wrote in a private letter to investors earlier this month which was reviewed by The Wall Street Journal. “But it is unclear how long that will take and what the new price equilibrium will be.”
Many economists and energy analysts believe that prices will probably rebound somewhat from current levels by the end of the year. The global benchmark for oil, currently $46.59, will “head back toward the $70 range and I suspect that will be sustainable for quite some time,” says Stephen P. A. Brown, an energy economist at the University of Nevada, Las Vegas and former economist with the Dallas Federal Reserve Bank.
The dollar increased in value in the early 1980s as the Federal Reserve wrung inflation out of the U.S. economy, but the Reagan Administration engineered a large devaluation in 1985 in agreement with other major economic powers. Between March 1985 and December 1987, the dollar lost 40% of its value against a basket of other major currencies. That stands in contrast to the current episode: The dollar rose more than 12% in 2014, compared with a basket of widely traded securities.
During the last big supply-driven oil bust, demand had been muted for several years, in part because of conservation measures Americans embraced after the Arab oil embargo in the 1970s. The country adopted energy-efficiency standards for cars, while using oil to generate electricity fell out of favor.
Meanwhile, oil output outside OPEC grew rapidly. Production in the North Sea surged, as did output from China and Oman. Mexico began shipping more than one million barrels a day in 1981 from its Cantarell complex. Even the American oil industry had started pumping more oil from its high-cost oil fields.
Changing prices at a gas station in Toronto in February 1986. Between November 1985 and March 1986, the price of crude plunged by 67%.
And so a glut developed. At first, as oil prices began retreating, Saudi Arabia tried to bolster prices by cutting its production, which fell from 10 million barrels a day in the early years of the decade to 2.3 million in August 1985, according to the U.S. Energy Information Administration. Late that year, tired of losing market share to rising oil exporters, the Saudis threw in the towel and began pumping again—and so did the rest of OPEC.
Global oil prices went into free fall, declining from over $30 a barrel in November 1985 to nearly $10 by July 1986. The U.S. oil industry basically shut down. In late 1985, there were nearly 2,300 rigs drilling wells; a year later, there were barely 1,000.
Prices spiked upward a few years later, prompted by Iraq’s invasion of Kuwait in 1990. But that didn’t last long, ending in 1991 once Operation Desert Storm pushed Iraq out of Kuwait and the fires set by retreating forces were put out. Afterward, prices remained low, bouncing between $15 and $25 until the end of the decade.
It wasn’t until about 2000 that supply began to struggle to keep up with rising demand. Global economic growth, especially in Asia, pushed demand for crude as the Chinese middle class began driving cars. Chinese oil imports, virtually nonexistent in 1985, have risen steadily ever since. On Tuesday, Chinese data hit a record of about seven million barrels a day.
Prices spiked in the summer of 2008, then plunged when the economy crashed and went into recession. But the price drop was brief and prices rebounded quickly. Today, demand for crude is growing, albeit slowly, around the world. The health of the global economy and Chinese appetite for fuel will have a significant impact on global and U.S. crude prices. An outside event—warfare or civil strife in a major crude-producing country—could raise prices again.
As in the past, Saudi Arabia is betting that low prices will force other producers to cut back. Falling prices will hurt U.S. output, but perhaps less than OPEC expected. The cost of producing oil from shale—especially in the new U.S. oil fields responsible for a huge upsurge in output—has been falling.
ConocoPhillips , a major U.S. oil producer, says it can make a profit on its U.S. shale wells as long as oil trades for more than $40 a barrel, a figure that has been falling in recent years. A Conoco spokesman said improved efficiency, better technology and a better understanding of the rocks helped the company reduce costs.
Which Oil Producers are Breaking Even?
And it is not alone. The expense of getting oil from the Eagle Ford Shale fell by about 15%, or $7.50 a barrel, last year, despite intense competition for rigs, truck drivers and oil-field services, says Pers Magnus Nysveen, head of analytics for Rystad Energy, a Norway-based global oil consultant. Costs could fall another 10% to 15% this year as some financially weak companies pull back and competition for services lessens.
“The key driver here is improved efficiency,” Mr. Nysveen says.
Companies like
EOG Resources Inc. are drilling better wells faster. EOG said recently it takes 4.3 days to drill its average well in the Eagle Ford Shale in South Texas, down from 14.2 days in 2012. What’s more, as it drills more of them, it has figured out how to locate wells to get the highest oil output.
Combining lowering costs and increasing output means that EOG says it can drill wells at $40 per barrel in North Dakota, South Texas and West Texas, while still earning a 10% return. We “pride ourselves on being a very efficient operator,” Billy Helms, EOG’s head of exploration, said at a recent industry conference.
Since oil prices began to fall, many companies have cut their capital spending plan for 2015 and the number of drilling rigs in the U.S. has fallen. But output has continued to increase.
Mike Rothman, president of Cornerstone Analytics, says that given the decreasing costs of drilling, it is not clear when shale output in the U.S. will fall.
“How quick will the response in shale oil be to this drop in prices? That is a big open question,” he says. “With shale, you are dealing with something very different.”
