The Oil and the Glory

The Weekly Wrap — Feb. 17, 2012

The war of tight oil: Are we in an age of oil plenty, or a stubborn era of scarcity? The folks with skin in the game are among those who cannot agree. At Citigroup, Seth Kleinman leads a group of analysts (including the venerable Ed Morse) who issued a note to clients this week declaring ...

STRDEL  AFP/Getty Images
STRDEL AFP/Getty Images

The war of tight oil: Are we in an age of oil plenty, or a stubborn era of scarcity? The folks with skin in the game are among those who cannot agree. At Citigroup, Seth Kleinman leads a group of analysts (including the venerable Ed Morse) who issued a note to clients this week declaring "the death of the peak oil hypothesis," a belief that there is a limit to how much oil can be produced. The actor in this murder is shale oil, the sister to shale gas, which is being unleashed from hard underground shale through the application of hydraulic fracturing. "The U.S. appears to be on course, after many weak starts, to achieve energy independence this decade," Kleinman writes. In a shot over the bow of doubters, the Citi team snickers at those who cannot notice the truth before their eyes: "We expect industry expectations to lag behind reality, just as they did with shale gas for many years." They go on to tally up how they see the new oil patch:

U.S. crude and product imports are now about 11 million barrels a day, with about 3 million barrels a day of product exports. This leaves import reliance at 8 million barrels a day. If shale oil grows by 2 million barrels a day, which we think is conservative, and California adds its 1 million barrels a day to the Gulf of Mexico’s 2 million barrels a day, we reduce import reliance to 3 million barrels a day. Canadian production is expected to rise by 1.6 million barrels a day by 2020, and much of this will effectively be stranded in North America, and there is the potential to cut demand both through conservation and a shift in transportation demand to natural gas by at least 1 million barrels a day and by some calculations by 2 million barrels a day.

Voila, U.S. energy independence.

Not so fast, say the analysts at Barclays Capital, who issued their own, nearly simultaneous note to clients saying the opposite. The note, by Paul Horsnell and Amrita Sen, suggests that Barclays’ clientele guard against "the near-euphoria surrounding the potential of oil shales in the U.S., together with a natural bias in the market to be overly optimistic on oil supplies." The oil market is extremely tight, made the more so by political upheaval, says the Barclays team. They write:

While posing some stirring prospects following almost a decade of dismal performance by non-OPEC supply, oil shales alone are simply not enough to offset the decline in other parts of non-OPEC and meet all the incremental demand growth. The scale of growth in U.S. output really needs to be put into perspective. North Dakota still only produces 0.5 million barrels a day, which in a weak year, incremental Chinese oil demand alone can consume all of and more. Does shale oil help the U.S. reduce its dependence on foreign oil? Yes, it does. But does it remake the U.S. into the next Saudi Arabia? No, at least not yet.

There you have it.

Go to the Jump for more of the Wrap.


Dispatch from the oil patch: When you start pumping shale oil, the flow is utterly unlike that of a conventional field — the oil comes out in a great burst, then tapers off rapidly; in order to maintain your production after the tens of millions of dollars you have spent to get the field ready, you have to drill in a new place nearby. And if oil prices drop, you are in trouble. Such is the gist of an email from an executive at a company working in the Bakken oil patch of North Dakota, which is at the vortex of the fresh mania that is sweeping the industry (as noted in the previous item), a belief by many that they all have been wrong all these years, and actually there is a glut of oil, at least in the western hemisphere. As suggested, the top line of this outbreak of enthusiasm is that the United States is on the verge of nirvana — energy independence. Earlier this week, I noted that these reports seem uniformly to omit the oil price necessary to make these estimated reserves economic to extract; nor do they discuss the natural decline in field production. In the absence of such data, the forecasts seem a case of irrational exuberance. The Bakken executive weighed in with a first-hand description of how the Bakken behaves. He gave permission to publish excerpts without his name or company:

While [conventional] oil fields may decline at a 5 percent to 8 percent rate, oil wells in the Bakken decline at an extremely high rate their first four years or so. The decline rate during the first 12 months can be more than 90 percent, tapering off each year, to flatten out by year seven or eight at an annual decline rate of 8 percent, by which time the well will have already produced about 60 percent of its recoverable reserves.

There are sweet spots, and there are areas that are not so good.  You can produce oil just about anywhere you drill, but — and it is a big ‘but’ — in many areas you might not recover enough oil (even with West Texas Intermediate oil at $100-plus a barrel) to pay for the well.  These areas may become profitable when oil hits $150 to $200 in real terms someday.

The Bakken formation basically has very poor porosity.  Multistage fracking (say 36 to 40 separate frack jobs spread over 10,000 of horizontal wellbore) cracks up this poor rock and allows a lot of the oil to escape very quickly. After that initial blast, the rock nearest the wellbore gets really fracked up, and the further away from the wellbore you go, the less fracked it is. The rate of production drops as the really close-up oil is given up very quickly and the well begins to produce more oil from the center and edges of the fracked area.

By keeping up a steady drilling pace, the oil production from the field will rise rapidly at first because the production from the new wells will exceed the loss of production for the old wells.  This is what has been happening in the Bakken. However, if the rate of drilling stays constant for a long time, the growth rate of field production will decrease, then plateau, then begin to drop, slowly at first, then accelerate to a higher rate, and then later settle at about an 8 percent annual rate.

And if prices drop significantly during the time when you would normally expect to see a high drilling rate (or if drilling costs get too high), you could see a sudden decrease in the rate of drilling, and a field like the Bakken will go from high growth to high decline really quickly. A drop of oil prices to $70 per barrel (of West Texas Intermediate) could create an extreme drop in drilling and field production really quickly.

Resource plays don’t work if oil or gas prices are low.  A huge part of the risk is evidenced by the Barnett Shale. It worked great at $6 to $15 per thousand cubic feet, but it loses money like crazy at $2.50 per thousand cubic feet.  The problem is that you really get clobbered when you drill the wells when gas or oil is high priced, and then the price drops and you have to sell your oil or gas at low prices.  Billions and billions of dollars have been lost in the Barnett because of this.  If oil drops to $70 (WTI), a lot of people will lose money in the Bakken.


Iran — lashing out, but still plenty of customers: The oil squeeze on Iran has the country’s leadership squirming and, if Israel is correct, engaging in bombing attacks in at least three countries. Iranian leaders seem rattled, and are even more than usually vocal on the Western-led effort to cut their ability to sell their oil, the bedrock of the country’s economy, write the New York Times’ Scott Shane and Robert Worth. Yet it is not clear as yet that the sanctions will achieve their objective of freezing Iran’s development of nuclear weapons. While the sanctions make getting paid a complex affair, the oil orders — from China, India, Japan and South Korea — appear in some cases even to be higher, writes Peter Enav of the Associated Press. Virtually every stage of international conflict benefits some party financially; in the case of sanctions, it is smugglers and profiteers who usually stand to gain. I have seen no reports as yet on a black market for Iranian oil, but perceived political risk flowing from the nuclear standoff has raised oil prices, and thus benefitted countries like Russia, reports the New York Times’ Andrew Kramer. This is because Russia’s Urals blend is roughly similar to Iranian crude, which many refineries are specifically fitted to process. All in all, the sanctions have been more effective than one would have expected in getting Iran’s attention. Causing Tehran to change course is another matter.

<p> Steve LeVine is a contributing editor at Foreign Policy, a Schwartz Fellow at the New America Foundation, and author of The Oil and the Glory. </p>