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Musings on oil since the price dropped September 16, 2014

Posted by shaferfinancial in Finance.
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I have seen folks around the internet saying that we have a glut of oil now. Many are predicting that tight oil [North American Shale for the most part] production has created a situation where deep sea exploration/drilling will drop significantly. Since I am invested in a couple of UW drillers [SDRL, AWLCF] I thought I would re-examine my original investment thesis.

Prediction is usually a tough business but I did find some consensus on future demand. Most folks think the long term demand in the US, Europe and Japan will go down slightly. While the demand in China, India and the Middle East will increase dramatically.

FutureOilDemand

Overall the prediction is for a 19 million barrel a day increase. So if they are correct, where is this 19 million barrel a day habit going to come from? Many are assuming tight oil. But, how much shale oil is there being produced now? Less than 4 million barrels. So over the next 20 years can we assume that the amount of shale oil produced will go up by a ratio of 5 times?

The most successful company in the shale oil space is currently EOG. Here is what their CEO, Mark Papa has been saying. The most productive shale plays have already been picked over and we are close to our peak production for shale oil. He is not alone in saying this. But for the time being let’s pretend over the next 10 years we can double the increase in production that has happened over the last 5. The CEOs of companies already into shale oil production would call that unlikely, but let us keep with that prediction. So we increase production by 3 million barrels. And let’s say that shale oil finds lucrative areas in the rest of the world that mimic North America’s increase in production. So we are up to 6 million barrels. Where is the other 13 million barrels coming from?

Now let’s talk price. That is the other myth being thrown around. That shale oil production is cheap. The truth of the matter is that NA shale oil costs about $65 barrel to produce. That compares to $52 for deepwater and $56 for ultra deepwater production. So we see that overall costs favor going underwater except for the Arctic which costs $75. Of course, getting shale oil has proved to be faster than underwater which can take up to 3 years for exploration and drilling. But, for the most part current shale oil is not cheaper than going deep into the oceans. As to the economics at least two of the major oil service companies’ CEOs have commented on the bad economics of shale oil [Shell, BP]. Bottom line is that oil has gotten very expensive to get out of the earth and is getting more expensive by the day. Shale oil has no particular advantage over drilling under the water even at huge depths.

Now let’s talk politics. We know that spills in the ocean are devastating and create all sorts of risk. But,the shale oil fans simply aren’t dealing with the risks of transporting these tight oils. Every month of late we have had a railroad car issue transporting oil and pipelines have their own dangers. This is already driving up costs as the US government applies more stringent regulations on rail cars.

Getting oil of the ground to market is a dangerous dirty business that creates environmental disasters all over the globe. But, there are no practical alternatives on the horizon yet, and no political will to deploy alternative energy at a high rate anywhere but Germany.

Until we see both advancements in alternative energy and the political will to deploy them we are stuck with oil.

Given all this, does anyone really think we see the price of oil plunge?

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