Not a popular theory yet, the “yo-yo” concept is based on a belief that US unconventional oil and gas really is just that: unconventional in the way it is produced and unconventional in the way it will behave in the future.
The biggest and most obvious difference is the relatively small amount of oil (and gas) produced from each unconventional well, and the vast number of wells drilled relative to better-known petroleum accumulations.
What that says to The Slug is that conventional theory about how producers will react to future excess oil and gas production could be significantly different to what’s happened in the past.
In previous periods of over-supply, oil producers behaved in a largely logical fashion of shutting in high-cost wells and waiting for demand to pick up and for the price to rise. The time period in those cycles of over-and-under production was generally between 12 and 18 months.
OPEC, the Arab-led oil cartel, believes that we are about to see a repeat of history with high-cost oil being displaced by low-cost oil, a process which seems to have started with some US shale drilling activity already being curtailed.
Baker Hughes, the US firm which produces a weekly rig activity count, reported that 16 rigs had stopped turning in the Eagle Ford formation of Texas and that 10 had been idled in the Bakken of North Dakota.
So far, so good for the conventional theory.
But, what makes The Slug suspicious of history being repeated is that shale wells are different in so many ways from conventional wells.
For starters, they’re shallower, cheaper and are fast to drill. They come on quickly and they fade quickly. In theory, they should also be easy to cap and cheap to re-enter when the price is right – and that’s when we get to the “yo-yo” theory of a world where the marginal cost of oil production is controlled by US shale – and by shale exploited elsewhere.
What might happen, and this theory is as good as that from the next man, is that shale producers will approach the current price challenge in two ways. They will close high-cost, low productivity wells quickly, if only because most of them are under pressure from their financiers.
But, the shale boys will also bust a boiler to find productivity and cost improvements because that’s the way American business always behaves when put under pressure.
Then there is the “one-size does not fit all shale” factor which is part of the overall “unconventional means unconventional” theory because some shale wells will not be able to operate profitably at $US70 a barrel, while others might still be profitable at $40/bbl.
And, lurking in the background is the mother-of-all features of shale: it is not only a new source of oil, but the surface of its potential has only just been scratched, and as technology continues to peel back its secrets it will remain a critical element in global oil output.
It’s for all of those reasons that OPEC’s tactics of flooding the market with oil to kill high-cost competition might turn out to be a significant mistake, for these reasons:
- The oil trapped in shale is not new, but the methods of discovery and extraction are;
- Those methods are rapidly improving as geological knowledge grows;
- The US is quite relaxed about cheap oil.
That final point is one the oil industry might not like to hear, but while low oil prices hurt all producers they are a big bonus to the world’s biggest oil consumer, the US.
What this comes down to is not a battle between competing types of oil deposit (which might be described as Saudi v US oil) it is a battle between old technology, old theories and inept management (OPEC), and new technology and slick management.
The end result could well be a yo-yo result with high-cost oil being quickly switched off to sit on the sidelines waiting for $75/bbl to return, and then be switched back on for a quick campaign – before being switched off again.
There are financial reasons why such an approach might prove difficult, but if any country in the world can manage through a financial challenge tossed up by an old enemy it’s the US.
The net result, unfortunately, is that it could be a long time before the oil industry sees a price of $100/bbl as the old and the new do battle.