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Long And Wrong In The Oil Market


Is Andy Hall on to something? The legendary oil trader is reportedly telling his investors that America’s shale energy boom will be coming to a swift end, sending oil prices skyward to $150 a barrel over the next five years. Such bold predictions helped Hall amass a small fortune; he was once awarded a $100 million bonus for his oil trading genius and bought a castle in Germany. So his words are being taken very seriously by the energy community, but that doesn’t mean everyone agrees.

Many in the trading community that I speak to think Hall has really got it wrong here; but such a fortress-like ego may be getting in the way of the facts.

While it can be argued (but not by me) that production might slow in the coming years, it is unlikely to fall off a cliff anytime soon. The combination of new and exciting advances in drilling technology with the geographic proliferation of exploration and production activities will lay Hall’s doomsday predictions low.

International oil prices have remained relatively flat over the last few years thanks, in large part, to a massive and unexpected increase in U.S. production. This was due primarily to major advancements in shale drilling technology, such as hydraulic fracturing (fracking) and horizontal drilling. Producers are now able to tap oil shale formations, many of which were considered too costly to exploit just a few years ago.

U.S. oil production this past June hit its highest level in 28 years at 8.5 million barrels a day, according to the U.S. Energy Information Agency. That’s an increase in production of around three million barrels a day compared with the same time in 2011, most of which is due to shale drilling. This, along with a tepid demand in the West and a slowdown in Chinese economic growth, has kept oil prices from rising in the face of growing geopolitical dangers in Libya, Syria, Russia and Iraq, all of which have knocked millions of barrels of oil off the international markets.

Hall never put much stock in the U.S. shale boom and maintained a bullish oil position even as market fundamentals were clearly turning against him. As such, Hall’s hedge fund, Astenbeck Capital Management, has taken quite a beating, costing both him and his investors millions of dollars. The fund was down 8.3% in 2013 and has continued to side this year as oil prices have tanked. Astenback’s investors have started to jump ship. Assets under management at Astenbeck fell to $3.4 billion this May, down from as much as $4.8 in January of last year.

Despite this performance, Hall still maintains that U.S. oil production will fall considerably over the next five years as the shale boom goes bust. He believes the seemingly endless reserves are being hyped up by the oil companies hoping to pump up their valuations. His assumptions are based on a belief that all the so-called “easy” oil has already been sucked out of the shale plays and that it will cost a lot more money for energy companies to squeeze any more oil out of them.

Hall doesn’t go into much detail as to why he believes all the cheap and easy oil is gone, but he does mention the high decline rates of newly drilled shale wells as being one of the primary problems with the boom. Indeed, the average flow from some oil shale wells can drop by as much as 78 percent in its first year of production, considerably more than with most conventional wells.  This forces producers to drill constantly to maintain production levels, increasing capital costs and squeezing margins.

Underestimating the impact of technology innovation

Ignored by Hall is that technology and innovation have been the driving forces behind the Shale revolution and will continue to play a major role in helping to extend its life well into the next decade. Some of the more promising innovations center around rig productivity, allowing drillers to produce more oil using less rigs and on smaller plots of land.

WSJ Production chart

The rig count at the oil-rich Eagle Ford shale play in south Texas, for example, has not changed since 2012 and yet production there has doubled. Advances in computer-aided drilling have contributed greatly to this expansion in productivity. Halliburton’s “Cypher” software program uses artificial intelligence technology to extract the largest amount of oil from a well in the shortest amount of time, while doing minimal damage to the reservoir. Schlumberger’s “U-ROC” software program performs a similar function and has been credited with increasing production in some wells in the Eagle Ford by as much as 30%.

New drilling techniques are also helping to keep the boom alive. In a technique known as “down spacing,” producers are drilling wells closer to one another in an attempt to squeeze more juice out of a tighter space. The results have been positive, with some companies reporting sizable production gains. But it doesn’t end there. Technology set to come on stream after 2020 could apparently keep the shale revolution going on indefinitely, according to a new analysis from Wood Mackenzie, the energy consultancy. Advances in enhanced oil recovery techniques that are in the early testing phase could double recovery rates and increase production from today’s numbers by about 1.5 to 3 million barrels per day. This would increase production forecasts by 25%.

It is easy to downplay the significance of all this innovation, but the fact remains that oil production continues to increase, depressing prices and enriching the nation. The U.S. government’s baseline projection for U.S. oil production sees it peaking in 2019 and then flatten out. But its “best case” scenario, which assumes that extraction technology improves (an argument I find highly compelling), has crude production rising through 2040 and beyond. 

EIA global shale map

Further, the shale revolution isn’t confined to the United States. There are many countries looking to adapt shale drilling technology to augment their own energy reserves, which could add billions of barrels of oil to the international market. The Energy Information Agency has identified 137 shale plays in 41 countries outside the United States that could produce significant amounts of oil and natural gas. Russia apparently has 75 billion barrels of technically recoverable oil shale, nearly double that of the U.S. Massive oil shale reserves also exist in China, Argentina and Australia – all waiting to be exploited.

The shale revolution in the U.S. isn’t going to last forever. Production may very well decline in the years to come as all the easy oil is brought up. But there is no clear indication that we are anywhere near that point, and lots of historical evidence that we continually discount to pace and impact of technology innovation.

Production in the Bakken oil shale play just hit one million barrels a day in May and shows no signs of falling. Producers seem committed to drilling more and more wells to fulfill production quotas. While it isn’t cheap to frack wells, it still garners great margins if prices remain above $70 a barrel. The higher prices go above that, the greater the motivation producers have to drill.

And when the curtain finally falls in the U.S., global supply will still be riding high of new finds in Russia, China, Europe and Latin America.

With technology and geography on the driller’s side, this boom is probably going to last far longer than anyone, even Andy Hall, can predict. What could save him and this position could be a severe political event, most likely in the Middle East that shuts in massive supplies. But as we say in the trading community, “right for the wrong reason is still wrong”.


10 Comments on "Long And Wrong In The Oil Market"

  1. Nony on Sat, 27th Sep 2014 7:31 am 

    go shale

  2. Plantagenet on Sat, 27th Sep 2014 9:34 am 

    Even if production from shale doesn’t collapse, production from conventional fields will steadily decline by 3-5% a year going forward. Either way oil prices are going up

  3. shortonoil on Sat, 27th Sep 2014 9:46 am 

    “International oil prices have remained relatively flat over the last few years thanks, in large part, to a massive and unexpected increase in U.S. production.”

    That’s what we thought was happening also; shale production was keeping prices down, but after taking a closer look at the data it turns out that is not what has been happening. Oil has been approaching its maximum supportable price. In regard to this article, Hall is half right, and Forbes is totally wrong. Hall thinks that shale production will crash, and in this respect he is right. We already see this happening in the Eagle Ford as condensate production from the formation is in steep decline. These mini reservoirs are hitting their dew point in increasing numbers. As this effect hits an increasing number of older shale condensate fields around the country, there soon won’t be enough rigs on the planet to compensate for their decline.

    Hall’s estimate that prices will go to $150/barrel is not likely to happen. If it does it will look like the 2008, $147 bounce, which immediately fell back to $30. Gail Tverberg published a report a few months ago where she stated that the economy could not support prices much above a $100/barrel. After rerunning some numbers we have now substantiated her estimate. We came to the conclusion that $117/b is the maximum price that the economy can afford to pay for petroleum. Prices can not go above that for any sustained period of time. If Hall gets his $147/b bounce, he had better sell his positions fast, before the bottom drops out again.

    Forbes, of course, is having its usual love affair with the technology genie. Drilling more wells from one pad occurred because she waved her magic wand, and presto. It had nothing to do with the fact that engineers have spent the last 60 years developing, and improving this technology. And presto, in the flash of an eye, she will come up with another wonder just in time to save the day.

    Forbes is back in fantasy land, and Hall is walking one mighty flimsy tight rode. If Hall pulls this one off, he will have earned it.

  4. ghung on Sat, 27th Sep 2014 10:21 am 

    Seems like a long-winded, complicated admission that we’re scraping the bottom of the petroleum barrel. Maybe it’s just me…

  5. forbin on Sat, 27th Sep 2014 11:31 am 

    well we aren’t we ghung?

    like a few days ago $68 tight oil , $5billions to get 0.4mbd

    not long ago , a few years back KSA boasted 12-15mbd , they cut now . could they ever do this? only KSA really knows


  6. Perk Earl on Sat, 27th Sep 2014 11:34 am 

    “If Hall gets his $147/b bounce, he had better sell his positions fast, before the bottom drops out again.”

    True enough, short. Personally I’d sell at a temporary spiking price of 125 and just be grateful I didn’t have to sell the castle in Germany – lol.

  7. shortonoil on Sat, 27th Sep 2014 11:47 am 

    “Production in the Bakken oil shale play just hit one million barrels a day in May and shows no signs of falling. Producers seem committed to drilling more and more wells to fulfill production quotas. While it isn’t cheap to frack wells, it still garners great margins if prices remain above $70 a barrel.”

    Of the 4,598 wells that we took a look at in the Bakken the cost of drilling the well averaged $53/barrel. $70 is certainly going to produce some impressive margins, and the price received by the producers at the well head is now close to $60. It looks like Forbes is trying to move some money. That is, from their readers’ pockets to their advertisers. The perfect investment for windows, orphans, and pension funds. These guys have the scruples, and integrity of a hammer head shark!

  8. Northwest Resident on Sat, 27th Sep 2014 12:13 pm 

    At least you know up front that a hammer head shark is interested in one and only one thing — to eat you for lunch. If Forbes were to post a disclaimer, something like “Our corporate mission is to sucker our readers out of every dollar they’ve got”, THEN they would have the integrity of a hammer head shark. But yeah, your point is well taken nonetheless.

  9. Harquebus on Sat, 27th Sep 2014 4:29 pm 

    The world’s economies will continue to decay and then collapse long before peak shale. They have already demonstrated that they can not afford unconventional oil.

  10. keith on Sat, 27th Sep 2014 11:13 pm 

    What is innovation? Dumping the radium socks any and every where. Destroying aquifer’s. Causing earthquakes. Leaving messes for future generations. To me, innovation is ignoring all the hidden costs that don’t show up until after bankrupcy.

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