Shale revolution is irreversible

Since 2010, American oil production has grown by about four million barrels per day (almost all of it extracted from shale formations), irreversibly changing our own, and the global, energy landscape. Our daily production now exceeds that of Saudi Arabia, OPEC’s largest producer and its key member, now struggling to understand the North American shale phenomenon and how to respond to it.

The Saudis correctly sense that something pivotal, and epochal, has happened in a very short time to world oil markets.

In response to global oversupply, the kingdom has chosen since mid-2014 to protect market share rather than maintain profits. In other words, it has turned away from its former ‘swing producer’ role (i.e., cutting production to maintain and/or boost prices) and now opts to boost production to further drive down oil prices and cripple higher-cost producers.

The Saudis have reasonably asked why they should prop up prices by acting alone to cut production when others both within and outside OPEC won’t follow suit. All producers want higher prices but most of them can’t afford to pump less. Unlike the Saudis or the UAE, many members of OPEC lack vast, cushioning foreign exchange reserves to pay for growing social programs. Nigeria, Angola, Venezuela, Colombia and other single source petro-states have no choice but to pump, and pump.

While major international firms are sharply cutting their exploration and production budgets in response to low prices and OPEC’s unwillingness to reduce production, the Saudis are treading a tricky path. They’ve spent a year trying to retain market share while undermining higher-cost operations such as deep water drilling, oil sands and ‘tight oil’ from shale. However, the world oil market remains oversupplied, and this could go on for some time yet.

Meanwhile, actually rolling back U.S. oil production remains elusive. Though the U.S. drilling rig count has fallen by over half since mid-2014, actual production has barely moved — even though some forecasters see it falling by half a million barrels/day by year’s end. In some formations, shale production actually continues to grow as homegrown producers focus on productive acreage, renegotiate supplier contracts and deepen oil field innovation. Since the oil price plunge, new well productivity is actually up by over forty percent. Recent analysis sees the industry basically managing, albeit with bumps and glitches along the way, to survive on a forty dollar/barrel oil price.

The situation spawns many ironies. The Saudis themselves may be largely ‘to blame’ for the shale revolution’s dramatic appearance. The previous decade’s stubbornly high oil prices provided an arena for the risk-takers and technological savvy of the shale revolution.

During that decade, OPEC and other producers grew fat on oil prices which, early last year, reached $110 per barrel. They were happy enough to nurse the recurrent fear of “peak oil,” i.e. the specter of near term, finite limits of global petroleum.

High oil prices bred new consumer habits and new competition. And muscular supplier cartels may now be receding into the past. Thanks to the oil producers’ high prices, the U.S. shale revolution reached the tipping point. In the future, innovation and competition could diminish OPEC’s luster still further, despite fierce cost pressures.

Ahead of us we can discern a new era, one in which oil prices no longer depend on foreign oil ministers acting in concert but on a more vibrant market. To be sure, shale production’s staying power will face many challenges — and the need for new pipeline infrastructure and upgraded refineries is just one of many. But an oil future friendlier to consumers and the U.S. national interest now seems clear.

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