New technology, high oil prices, and plentiful cheap credit have encouraged the boom. Some $200bn has been borrowed to invest in fracking in the last few years, accounting for 15 percent of the entire $1.3tr US junk bond market. Investors were, in effect, betting on continuing high oil prices making their investments profitable for years to come.

Last year’s slump in prices trashed that calculation. From a mid-year high of $115 per barrel, by the end of 2014 the price per barrel had fallen by more than 40 percent. More than half of US shale rigs have been laid up since October.

The driver, last year, was the behaviour of OPEC – the Organization of Petroleum Exporting Countries. OPEC is a cartel agreement among major oil producers that seeks to manage the international market for oil. With oil prices already plunging over the summer, OPEC could be expected to ease off on production. Restricting supplies should, thanks to the magic of the market, produce a decent increase in the sale price of oil. Instead, with Saudi Arabia taking the lead, OPECdecided to continue production levels. No agreement on restricting output could be reached. Prices slumped.

The economics of oil production are simple – crude, even. The upfront investment needed to sink a new well is significant. After that point, however, the variable costs – including pay – are a minimal part of the expenditure. That’s the case even when, as in Norway, oil workers’ average annual wages are $179,000.

These high initial costs, relative to lower running costs, mean that once a well is drilled the owner has a huge incentive to keep on drilling – even at very low prices. If they can cover their immediate costs, which are low relative to the initial outlay, they can make a profit in the short run.

But that creates a ratchet effect: once a well is drilled, only a spectacular fall in the price of oil will stop oil from being pumped. The more oil is pumped, however, the lower the price is likely to fall. Each producer, in this scenario, is trapped into producing more and more, driving down the price further and further. This effect has meant the slowdown in US shale output has been far slower than might have been expected, given the dramatic decline in price.

Adam Cohn via Flickr. Creative Commons 2.0.

It’s only with a cartel, like OPEC, that this ratchet can be broken. Because it is formed by states, rather than private producers, OPEC can afford to run against the logic of the market. In the case of Saudi Arabia, with cash reserves of around $800bn, it can afford to run against the market logic for a very long time. OPEC seeks to maximise revenues for its members. Generally, that means all members agreeing to restrict supplies, and then holding to their agreement. Instead, confronted with falling oil prices, OPEC has worked to increase its supplies, apparently working directly against its own interests.

Disentangling motivations from the conflicting claims is unclear. But the net effect of this drive to expand was to plunge major non-OPEC producers into serious crises. Late last year, attention was focused on Russia. The Russian Government is dependent on oil and gas revenues for about half its income, a dependency it shares with other large oil and gas exporters. This means that any decline in oil and gas prices immediately squeezes government revenues, alongside its wider economic impact.

However, the Russian Government also has deep pockets, having built up reserves estimated at around $400bn during the boom years of the 2000s. The plummeting oil price was expensive, but not disastrous if prices stabilised – as, eventually, they did, in early 2015.

The major victim of the price plunge was not Russia, but the US fracking industry. The critical number in all this is the ‘break-even’ price of oil. This is the oil price at which any given well starts to turn a profit. For US fracking, that’s $70-77 a barrel.  At current oil prices, US frackers are staring at heavy losses. Conventional oil is far cheaper, with the break-even price in the Middle East running at $10-17 a barrel.

But since many oil-producing countries are financing themselves on the back of oil sales, imposing taxes to fund state expenditures, the true break-even price (including the cost of paying for the government) for most major producers is far higher. For Saudi Arabia, the ‘fiscal’ break-even price (including payments needed to keep the government afloat) is around $92 per barrel. For other OPEC producers, it can be far higher – $116 per barrel in Iraq, for instance.

So low prices impose a significant loss on these states. But since they are states, rather than heavily indebted private producers, they should (in theory) be able to bear the losses. Even with reserves on the scale of Saudi Arabia’s, it is a high-risk strategy: something like a game of chicken, with OPEC relying on US shale’s shaky financing to lead to its collapse. It may be working: major US shale operators, drowning in debt, are suspending dividend payments to shareholders in a bid to conserve their cash.

The strategy seems clear. By using its market power to squash oil prices now, OPEC producers can hope to deter future investors from US shale – and indeed other high-cost alternative sources, like Arctic drilling. In doing so, they can continue to claim a major share of the market, and maintain their own dominant position.

That, at least, was the situation at the end of last year and into this year. And with US shale reeling, output dropping over the year, OPEC has hinted at future tightening of production, leading to a rising oil price once more.

But events in China point to difficulties ahead. ‘Black Monday’ saw China’s stock market boom come crashing to a halt, with share prices falling through the floor despite heavy-handed government intervention – including a pledge of $485bn to buy shares. China’s markets may now look calmer, but the bursting bubble has made clear that the country’s extraordinary, decades-long transformation into an economic superpower is now winding down.

China’s seemingly insatiable demand for raw materials, including oil, is easing off. And as it eases off, the oil price has started to look shaky once more. OPEC’s costly gamble may now be falling foul of a slowing global economy.

22 Comments on "How Fracking Changed the Economics of Oil Production Around the World"

forbin on Tue, 8th Sep 2015 8:19 am 



” By using its market power to squash oil prices now, OPEC producers can hope to deter future investors from US shale ”

seems actually if you research this even with google that OPEC hasnt done much at all , even KSA has’nt pumped 15million B’s of oil and stuck to just over 10 , and that the market fundamentals for LTO and shale is actually quite shaky – too much debt . they must keep pumping to make interest payments on it (USA that is )

As for KSA I’d posit they are pumping to keep flow going , if they cut back they know the ultimate extraction will be hurt . So to meet their goal of max the resource, the max amount of oil that can be produced , they keep at a nice steady rate ( until its gone ofcourse) but that’s a different game to a pub-co

Forbin

Fat Lady on Tue, 8th Sep 2015 8:30 am 



The only places that c+c production has increased in the world in the past couple of years is the US and Canada. What has changed? The price is bottoming out causing the frackers and tar sands operations to shut in operations that caused the “glut” in the first place.

Nony on Tue, 8th Sep 2015 10:09 am 



Nice article. Surprised by seeing it in smog blog.

US is up a lot over the last 5 years. OPEC is up a lot over the last year. See here:

http://econbrowser.com/archives/2015/08/opec-and-world-oil-supplies

BobInget on Tue, 8th Sep 2015 10:47 am 



Did ya hear?
Saudi Arabia and Iran are in a ‘state of war’.
Both OPEC members, what could go wrong already has.

Saudi Arabia just doubled down and paid
Qatar to send 1000 troops into Yemen, the next Syria. This seems to have gone unnoticed.

Venezuela, Iran, Iraq, Angola, Algeria, Nigeria,
Libya, Ecuador, all OPEC, all suffering terribly.

USA will not go bankrupt because of oil too cheap. Small to moderate sized oil companies will. When demand overwhelms, how quickly will
these denuded on verge of bankruptcy companies recover?

Venezuela has been forced into the arms of China and Russia for which they will be beholding for decades. Nigeria, Ecuador,
Angola, all now in hock up to ears, dependent
China and Russia.

We’ve been led down a on direction garden path. Our best fall-back asset, Natural gas, thanks to fraccing.

Boat on Tue, 8th Sep 2015 11:13 am 



The ‘fracking revolution’ has transformed the economics of oil production globally, with the US becoming a bigger producer than Saudi Arabia and – after decades of dependency on oil imports – even being able to export some of its surplus production.

How can you call any US oil surplus when the US imports a net 5 mbpd?

Boat on Tue, 8th Sep 2015 11:16 am 



Fat Lady on Tue, 8th Sep 2015 8:30 am

The only places that c+c production has increased in the world in the past couple of years is the US and Canada. What has changed? The price is bottoming out causing the frackers and tar sands operations to shut in operations that caused the “glut” in the first place.

There are drillers all over the world. Picking out frackers as a reason for a glut is a onesided view.

rockman on Tue, 8th Sep 2015 12:10 pm 



An alternative title: How the Economics of Oil Prices Changed the Dynamics of Frac’ng. For the good initially…and now for the not so good. LOL.

Fat Lady on Tue, 8th Sep 2015 12:43 pm 



Yes Boat Fracking is going on elsewhere around the world. However of the current “glut” of production world wide, the countries of US and Canada are the two showing any real significant production gains today.

shortonoil on Tue, 8th Sep 2015 7:35 pm 



Shale fracking definitely changed the world of oil; they showed everyone how to lose a lot of other peoples’ money:

http://www.zerohedge.com/news/2015-09-08/biggest-red-herring-us-shale

The biggest complaint of the article above is that the author is using BOE which includes gas production. Wet gas is selling at the well head for less than $2/ MM. Loses are much greater than claimed.

Any hydrocarbon production that is not energy positive over its full production cycle can not be economically positive. Feed stock production has always been a salvage operation for conventional crude; to make it a primary production product is a guaranteed loser. That is why the shale industry has had to rely on one of the biggest PONZI schemes in history.

Shale has certainly changed how the oil industry works. They have shown everyone how to pay yourself a few $million per year while losing a $trillion of other peoples money. All it took was the “we’ve got new ground breaking technology meme”, and the suckers piled in!

http://www.thehillsgroup.org/

Makati1 on Tue, 8th Sep 2015 8:12 pm 



“The Oil-Sands Glut Is About to Get a Lot Bigger”
“Financial Sector To Cut Credit Supply Lines For Oil And Gas Industry”
“U.S. tight oil production decline”
“U.S. natural gas production waning”
“The Real Long Term Threat To The Oil & Gas Industry”
“Oil Industry Needs to Find Half a Trillion Dollars to Survive”
“As oil plunges to US$38.24, mood in Alberta ‘is like a boxer taking too many hits'”
“As oil industry reels from price rout, layoffs stun U.S. workers: ‘I never envisioned this'”
“Oil sands producers dig in as slump worsens”
http://ricefarmer.blogspot.fr/

five weeks of fun in the oil patch. LMAO

Boat on Tue, 8th Sep 2015 8:37 pm 



Short,
More horse manure. Buying stock, bonds or mutual funds are a personal choice. Historically they have done very well over the long haul.

Boat on Tue, 8th Sep 2015 8:42 pm 



Mak,

It’s true Many US frackers and their Canadian oil producers have taken big hits. But world wide there is more oil available than ever before. The doomer patch has never had it worse. We have a few in denial but they will come around. forget oil decline and wait a couple decades for climate change. Stock up on coffee, it will be awhile.

ghung on Tue, 8th Sep 2015 9:58 pm 



Boat says: ” Buying stock, bonds or mutual funds are a personal choice. Historically they have done very well over the long haul.”

Boat thinks history doesn’t change. Silly, that.

apneaman on Tue, 8th Sep 2015 10:10 pm 



Drilling boom means more harmful waste spills

http://www.chicagotribune.com/news/nationworld/ct-drilling-harmful-waste-spills-20150908-story.html

GregT on Tue, 8th Sep 2015 11:33 pm 



“Historically they have done very well over the long haul.”

Past performance is no guarantee of future results. Exponential growth cannot continue on forever Boat. It is both physically, and mathematically impossible.

apneaman on Wed, 9th Sep 2015 12:16 am 



Fracking Fallout: New Analysis Reveals Over 100 Million Gallons of Toxic Wastewater Spilled Since 2009
Associated Press investigation finds more than 180 million gallons of fracking byproduct spilled from 2009 to 2014, tainting agricultural land, poisoning drinking water, and sparking the mass die-off of plant and animal life.

http://www.commondreams.org/news/2015/09/08/fracking-fallout-new-analysis-reveals-over-100-million-gallons-toxic-wastewater

apneaman on Wed, 9th Sep 2015 12:18 am 



STATES RARELY PUNISH COMPANIES FOR OIL WASTEWATER SPILLS

http://hosted.ap.org/dynamic/stories/U/US_SALTING_THE_EARTH_ENFORCEMENT?SITE=AP&SECTION=HOME&TEMPLATE=DEFAULT

Makati1 on Wed, 9th Sep 2015 6:53 am 



Boat, we grow our own coffee on the farm. Also cacao for chocolate.

When those tar sands and fraking fields close down. it will likely be forever. You must not understand that there will not be the financial resources to start them up again or the demand for their oil because this down will stay down.

I hope you are preparing for a totally different future, much like 3rd world countries today, if you are lucky.

shortonoil on Wed, 9th Sep 2015 7:04 am 



“Historically they have done very well over the long haul.”

They have done very well?? Here is an industry with gross sales of $360 billion per year, total debt of over $1 trillion, and absolutely no hope of ever paying that debt back. This must be a new definition of “doing very well”? It must be NewSpeak for frackers?

Anyone who believes that is a candidate for flying pigs, green cheese moons, and freshly painted bridges. The spin only goes so far, then you run into reality.

The reality is that the oil industry is in big trouble, and it is only going to get worse. Oil is no longer the savior of our modern world – it has become its nemesis!

http://www.thehillsgroup.org/

Kenz300 on Wed, 9th Sep 2015 8:20 am 



KSA’s big problem is their internal subsidies for oil that is increasing their internal demand at an unsustainable level. The more they use internally the less they have to export. It is time to end oil subsidies.

The Above Ground Oil Field: or, why $65 and $94 oil are inflection points for renewable fuels : Biofuels Digest

http://www.biofuelsdigest.com/bdigest/2015/09/07/the-above-ground-oil-field-or-why-65-and-94-oil-are-inflection-points-for-renewable-fuels/

Kenz300 on Fri, 11th Sep 2015 7:19 pm 



When Iran starts selling their oil to the world ….. the frackers will get a chill down their spines……

Banks have already stopped lending to frackers……

The bankruptcies continue……

Boat on Fri, 11th Sep 2015 9:04 pm 



Kenz,
Frackers seem to be doing very well with nat gas.