Exploring Hydrocarbon Depletion
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Page added on June 13, 2012
Whenever oil prices surpass US$100 per barrel, a certain group of well-known economists and investment banks re-emerge to tout their dire warnings that oil will soon top US$200 or more because of peaking oil supplies. Several bestselling books have been written warning that the world’s supply of oil has peaked and we had better prepare for the day of reckoning when there will be global shortfall of crude.
I must admit the data, especially given the rapid growth in demand from emerging countries, seemed very compelling five or six years ago. So much so that even the contrarian in me capitulated and I was an active participant among those predicting a global shortage of energy.
Times certainly have changed and so have I. Very few observers, if any, were able to predict the enormous impact new technologies such as horizontal multi-stage fracking would have on unlocking supplies of oil and gas once thought unrecoverable. There seems to be no shortage of news these days about the vast amounts of unconventional oil and gas being discovered in North America, Russia, China and several other countries.
A great example is the Bakken oil play in North Dakota, which is forecast to produce one million barrels per day by the end of the decade, up from the current level of 500,000 barrels and the mere 60,000 just five years ago. Plays such as this have resulted in total U.S. oil production setting new highs while domestic demand is still at 2008 recessionary levels. Consequently, refined products last year were the largest component of U.S. exports, which hasn’t happened since the 1940s.
Similar developments are happening all over the globe. A story this month in Forbes highlighted a massive oil field in Western Siberia called Bazhenov, which is estimated to cover 2.3 million square kilometers — the size of Texas and the Gulf of Mexico combined. This field would be 80 times the size of the Bakken play, the article states.
To figure out what these developments mean for oil prices, let’s take a look at what happened in the North American natural gas market five or six years ago. Back then, there were doom-and-gloom predictions of a shortfall of natural gas in North America and that higher prices and volatility were here to stay. The universal buy-in was so pervasive that it resulted in LNG import capacity being overbuilt.
Industry responded to high natural gas prices by deploying a massive amount of capital towards developing unconventional natural gas reservoirs using horizontal multi-stage fracking. Now we have a situation where there is a large glut of landlocked natural gas that has resulted in reduced natural gas prices with large price spikes being a thing of the past.
It’s worth noting the global markets for crude oil and natural gas are different because of the strong demand coming from emerging countries such as China and those in southeast Asia. For example, while North American gas prices have fallen to US$2.50/mmBtu, Asian LNG is currently fetching a whopping US$18/mmBtu.
In addition, new oil drilling and fracking technologies are very expensive. The research we’ve read shows the cost of developing many of these unconventional oil plays requires a break-even price ranging from US$60 to US$130 per barrel, depending on the play type, which happens to be quite similar to the breakeven price for many Canadian oil sands projects.
Many of these unconventional fields also exhibit high initial decline rates to the tune of 60% to 80% in the first year alone. Therefore, should there be any prolonged downturn in oil prices, the high cost structure of developing these plays would result in less overall third-party capital being made available to keep up the pace. The end result would be a supply response to the downside.
Therefore, don’t expect a return to the days of ultra low oil prices, but at least we’re headed in the right direction with regards to minimizing the probability of large spikes in pricing because of sudden supply disruptions in the Middle East. Perhaps one can even hope for a more normalized pricing environment that better represents the overall strength or weakness of the global economy at the time.