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Page added on October 10, 2014
Michael Lynch: Oil Prices And Costs Correcting Misperceptions
The decline in oil prices, Brent dropping $15 a barrel in 8 weeks, has concentrated the minds of the oil industry, and raised the prospect of falling investment in oil production. This argument is used to support the idea of long term oil prices being above $100.
The interaction between upstream costs and prices has long been a contentious issue. At a conference two years ago, Total CEO Margerie questioned my intelligence, after a fashion, for suggesting that long-term oil prices might be as low as $60 a barrel. Marginal costs, he insisted, were $100 a barrel, and lower prices would reduce investment and supply, and thus tighten markets again, bringing prices back up. This view is prevalent in the industry and among many investors, but needs careful examination.
In the first place, short-term marginal costs are usually half or less of total costs, that is, including capital costs, and so the price at which production would be shut in is far below that of the full, long-term marginal cost. This does not conflict with the Margerie view, of course, but is worth keeping in mind when trying to interpret the short-term, long-term cost behavior.
And other factors are important besides raw prices and costs. Shutting down some operations would be expensive: well abandonment costs, yielding leases, and so forth do not appear attractive if prices appear to be dropping only briefly.
But new investment could react quickly, especially for smaller companies which tend to rely on cash flow for their operations. This is what happened to Chesapeake Energy when natural gas prices dropped, forcing it to divest many assets to right itself. Industry debt levels are relatively high at present, and lower revenues would see a cut back in upstream expenditures.
Large projects like deepwater developments are hardly going to stop because of a dip in oil prices, as the major companies usually have deep pockets. A decade ago, when prices began to rise, they mostly embraced “capital discipline,” having been burned badly when the price collapsed in 1998. (Mobil and Texaco are gone, in fact.)
The biggest uncertainty comes from the degree to which higher costs reflect depletion, as in “the easy oil is gone,” or cyclical cost increases from booming activity. Price bulls and peak oil advocates embrace the prior argument, while I would insist that the latter is more influential. Given that oil prices were about $30 a barrel (adjusted for inflation) for 140 years, then shot up in the last ten, it’s kind of hard to believe that the “easy oil” disappeared so suddenly.
And there has clearly been cyclical pressure on costs, with rig operating levels extremely high and soaring costs for skilled workers, among others. Wages for fast food workers in North Dakota are 50-100% more than elsewhere, in order to make them competitive. [1] This is not because we are running out of Big Macs, or due to the fact that all the “easy” workers are gone.
So, lower oil prices should see a retreat in upstream investment, but a small drop in drilling activity should translate into lower costs for drilling, offsetting much of the decline in investment. A few major projects might be postponed, or delayed for redesign, but much of the impact of lower oil prices will be lower revenues for major oil producing countries and their governments. The oil service industry will be squeezed, as will those producing companies that are laden with debt, and LNG export projects will look less attractive, but there is no reason to believe that prices can’t remain at a new lower level of $80-90/barrel for Brent without major dislocations.
Of course, that could lead to political upheaval in Venezuela, which is already teetering on the brink, and potentially a new supply disruption. And stability in the $80s would probably not affect non-OPEC supply, and certainly not expansion in Iraq, where costs are below $10 a barrel, so that it would probably not represent a new long-term equilibrium.
21 Comments on "Michael Lynch: Oil Prices And Costs Correcting Misperceptions"
Northwest Resident on Fri, 10th Oct 2014 4:21 pm
Sure, let’s compare “easy to get” fast food workers with “easy to get oil”. That comparison is going to make total sense to a lot of people.
But let’s look at the other side too:
As Fracking Enters A Bear Market, A Question Emerges: Is The Shale Boom Built On A Sea Of Lies?
“Marathon’s Tillman, who was speaking at the Barclays Plc CEO Energy-Power Conference in New York on Sept. 3, said there are “risk and uncertainties that could cause actual results to differ materially from those expressed or implied by” his comments. Many company presentations remind investors that publicly announced estimates are more speculative than the numbers the drillers file with the SEC.
Figures the company executives cite during presentations “are used in the capital allocation process, and are a standard tool the investment community understands and relies on in assessing a company’s performance and value,” said Lisa Singhania, a Marathon spokeswoman. The Houston-based company’s shares have risen 1.6 percent in the last year.
The SEC requires drillers to provide an annual accounting of how much oil and gas their properties will produce, a measurement called proved reserves, and company executives must certify that the reports are accurate.
No such rules apply to appraisals that drillers pitch to the public, sometimes called resource potential. In public presentations, unregulated estimates included wells that would lose money, prospects that have never been drilled, acreage that won’t be tapped for decades and projects whose likelihood of success is less than 10 percent, according to data compiled by Bloomberg. The result is a case for U.S. energy self-sufficiency that’s based more on hope than fact.”
York on Fri, 10th Oct 2014 5:51 pm
What is happen in every 2 years, mostly in mid of that years(08, 10, 12, 14), with OPEC productions?
http://peakoilbarrel.com/wp-content/uploads/2014/10/OPEC-12.png
So, maybe someone now can understand why USA politicians so subordinate to Saudis and other Gulf states even if part of their societies are connected with 9/11 and most islamist terrorist organizations in the world.
trickydick on Fri, 10th Oct 2014 10:01 pm
Israel?
Nony on Fri, 10th Oct 2014 10:22 pm
It’s the Illuminati. They got Mike Ruppert…whoo is that? Aghlkjojowefl
Dave Thompson on Fri, 10th Oct 2014 11:03 pm
The tar sands/fracking ponzie scheme will fall apart at the seems if the crude price continues downward. I am thinking much less then $80 WTI, the “investors” start head’in for the exits.
Makati1 on Sat, 11th Oct 2014 4:34 am
On topic: “US Shale And The Slippery Slopes Of The Law”
“…The shale industry runs on debt, not on energy. And as long as these companies can issue junk bonds at low rates, they will. But that doesn’t mean they will ever be profitable. For their owners, sure, they’re raking in dough like it’s Halloween candy, but for investors in those bonds things don’t look so rosy. Shale is a Ponzi.
And US law allows it to grow. One set of reserves gets presented to the regulator (SEC), and an entirely different one to the investor. One company, Rice Energy, tells investors it has 27 times as many reserves as it tells the SEC….”
http://www.theautomaticearth.com/us-shale-and-the-slippery-slopes-of-the-law/
Glad I don’t play these silly games…
Nony on Sat, 11th Oct 2014 11:34 am
Majority of these companies equities are held by institutions (funds). CLR is 70% private. Many of the companies are 100% private. The reason they can raise debt is they have collateral. If the value of their assets goes down it will be from a general price collapse in oil, not from “running out” or from “it being a bubble”.
And if price crashes and a few shale companies go bust, who cares? If Rock has to spend more time on the boards, less on the mudlogger, who cares? I want petroleum exploration to lower price (or at least to limit the rate of increase). If prices drop so much that some people exit the market, I could care less. I’m not trying to employ Rockmen, but to satisfy the consuming public. POWER TO THE PEOPLE!
Davy on Sat, 11th Oct 2014 11:39 am
Noo, they have collateral until it ain’t or is that not running out or not in a bubble.
Nony on Sat, 11th Oct 2014 11:58 am
Oh well. A few bondholders lose their investment. These ain’t T-bills.
Davy on Sat, 11th Oct 2014 1:19 pm
Noo, it is ashame the bad news is overweight now in so many areas. You seem a bit down. Noo, are you getting a case of the doom creep?
Nony on Sat, 11th Oct 2014 1:29 pm
I’m actually only about 15 degrees right of Rock on the issue of shale and oil price. I’ve always agreed that the production would turn off if price drops. And I welcome that!
Where my needle is pointed more true North is that I recognize how shale has helped “hold the line” at ~100. That without it, price goes even higher.
Northwest Resident on Sat, 11th Oct 2014 1:46 pm
Nony, shale has never been an energy play, it has been for the most part a purely financial play. The amount of net energy added to the global economy by shale oil and made available to consumers is very close to zilch, and may even be a little in the red when all factors are considered. Shale oil has kept the wheels of BAU turning these last ten years or so, that is true, but to keep those wheels turning also required (and requires) massive volumes of debt because fracking does not pay for itself. The fact that we are reduced to fracking is proof positive that our civilization is dangling at the end of its rope with the sinews fraying rapidly fraying. That rope won’t hold much longer, fracking or no fracking, and who knows how far we’ll fall when the rope finally snaps.
Nony on Sat, 11th Oct 2014 2:20 pm
NWR: Stick to what you know. Stop spouting slogans you don’t understand and have heard here.
Shale does give more energy than is put into it. If price is high enough, it will be developed. Most of the products coming from the oil are gasoline, not plastics. So yes, definitely it is an energy play.
Dave Thompson on Sat, 11th Oct 2014 8:32 pm
http://www.dailykos.com/story/2014/10/10/1335717/-The-Frackonomics-Con-Job-about-to-be-Exposed
Northwest Resident on Sat, 11th Oct 2014 9:11 pm
Nony — What I know is that when it comes to fracking, you are an unrepentant fracking cheerleader who seems to believe that fracking is the answer to the world’s energy needs.
What I also know is that fracking is NOT a solution to the world’s energy needs, and the excessive debt taken on by fracking companies is the only way they are able to continue operations. The liquids (including oil) produced by fracking are on average far less energy intensive than a conventional barrel of crude. And it takes far more energy to get that average barrel of fracked fluid out of the ground than it does to get the conventional barrel of oil out of the ground. How can you deny that?
I’ve read enough articles and comments from highly qualified people to know what I’m talking about. I’m not even going to try to find those articles to post here for you, because you’ve seen them before and either blocked them from your mind or refused to recognize the truth in them.
What slogans am I spouting? I wasn’t aware that I was “spouting slogans”. If you could point out a slogan or two that I spouted, then I would really appreciate it.
Nony on Sat, 11th Oct 2014 10:21 pm
I bought gas for under $3! Woot!
Northwest Resident on Sun, 12th Oct 2014 1:45 am
Nony — Referencing the article posted above by Dave Thompson. Ask yourself this question. If fracking is providing net energy to the economy, then why the hell are fracking companies so deeply in debt, and why do they need to lie and scheme and misrepresent to attract the investment “sucker dollars” that are so vital to their continued existence? What’s wrong with that picture?
“Shale does give more energy than is put into it.”
You’re right, but so am I. The net energy from shale IS “probably close to zilch”. Depending on your definition of zilch.
“The most reliable studies suggest that the EROI for oil shale
falls between 1:1 and 2:1 when self-energy is counted as a cost.”
An Assessment of the Energy Return on Investment (EROI) of Oil Shale
ht tp://www.circleofblue.org/waternews/wp-content/uploads/2010/08/oilshale-assessment-2010-for-water.pdf
Compare that to 20:1 for conventional oil, and you see why I chose the word “zilch”. I don’t even know what that word means, but it conveys the main idea I think.
And that main idea is, while fracking companies are taking on HUGE debt and lying and scheming to attract even more investors, more debt, the amount of energy they are providing to the economy is real damn close to ZILCH.
Consider also that barrels of oil produced by fracking amount to a closely approximate ZILCH when compared to global oil output, then you get really close to the point I made earlier, which is that “shale has never been an energy play, it has been for the most part a purely financial play.”
Davy on Sun, 12th Oct 2014 6:56 am
NR, Noo is in his skin tights jumping around with the girls again. Noo is pawning snake oil. Snake oil is exciting and reality boring. Noo’s life is grounded in “life is good”. He is a shale sucker who sees shale as the foundation of a “good life”. Noo is the highest order corn. I applaud the shale folks. They bought me some very valuable time that allowed me to make important preparations. I will applaud them for the time they gave BAU. US production maintained supply growth. I would not put my faith in the shale bubble any longer. The S&P is in a 20% correction off highs and Brent in a bear market breaking through support levels. I can’t wait until tomorrow it could be an across the board blood bath with the BTFD’ers hiding out, the rampers laying low, and the HFT’ers sidelined. I would not put it past the racket to stabilize the situation in a concerted world wide effort, yet, diminishing returns have hit their tools. Confidence may be lost. We may have an oil war going on with the US/KSA willing to sacrifice the equity market highs for Russian pain. Energy is such an important component to the equity markets. I have read the drop in oil may have triggered the latest stock sell off. In any case no one can deny the elephant in the room of dismal world growth. Dismal growth despite applied debt at levels never seen before in the history of man. Those debt levels are now a world growth liability. Is life good Noo or just that pleasant buzz before the hangover? Every indication is we are in a bear market now folks with one arm tied behind our back and a blindfold on. No one knows what a “new normal” bear market will look like.
marmico on Sun, 12th Oct 2014 7:12 am
Energy is such an important component to the equity markets.
The Energy SPDR (XLE) is weighted 9.3% of S&P 500 market cap whereas the Technology SPDR (XLK) is weighted 22%. Investors view technology as more important than energy.
Davy on Sun, 12th Oct 2014 7:34 am
Marm, a weighted 10% in a bear market is enough to trigger a bear market. Last I looked Tech is not booming.
Northwest Resident on Sun, 12th Oct 2014 10:30 am
Davy — You’re highlighting some very inconvenient truths for the frack-loving Cornies. Nony and his peers must be twisting and turning at night, sweating in their tortured sleep, having recurring nightmares of technology advances that make no difference, of fracking “reserves” that turn out to be duds and shale investment that is dissipating slowly at first but ever more rapidly.
Shale oil has been a primarily financial play. It has kept the oil workers very gainfully employed, the refineries refining, the financial advisors advising, the investment gurus pontificating, the economy churning to the minimal extent needed to keep it from collapsing, the masses believing in BAU forever. But you are right, it is all coming to an end. That loud screeching noise we hear is the wheels of BAU grinding to a halt.