Monday, 10 August 2015

Oil collapse - a gift to the West.


There are some rulesabout the oil market which are being tested to production. One if the economics of sunk costs. It is very expensive to get an oil filed discovered, permitted, drilled and flowing. Literally billions of dollars for the larger fields.

Once this money is spent, then it is gone. Once the oil is flowing it is well under $10 a barrel. So if you have spend the money opening a field, it flows forever. Only accountants look at the overall economics. Countries do not budget like this, they work on a current account only formulae, once money is spent it is gone, worry about income for next year, not last year.

So once a large Petro-state has switched on the oil taps they never ever get turned off. The most an OPEC cartel decision can do really is limit the future expenditure on increasing production and hope that current fields run out.

Of course, with Shale in the USA it matters more whether the companies make money, but not so much more, such is the complexity of debt interest and leverage that overlays the industry. Plus the cost of drilling shale have already been absorbed, you may as well pump it.

Thus, despite a moderation in demand and a huge over-supply of crude oil, the world's petro states keep pumping. They need the money, even Saudi Arabia is likeley to have a 20% budget deficit this year. The oil will flow more and more and the price will keep dropping.

Today the price of crude is back under $50, as noted here before this is bad for the Middle East, Russia, Venezuela and Nigeria (and Scotland...). It is good for USA, Europe, China and India.

With Oil below $50 the inflationary pressures in the West are very benign, allowing the recovery from the Financial Crisis to continue. Russia will have a harder time justifying invading Ukraine and there will be less money to be funnelled to ISIS from its, err, 'enemies.'

Harder today to see is the dynamic really changing, demand in China is increasing more slowly and the West keeps investing crazily in renewables just when conventional prices are weakening. Plus the revolution that is LNG is still yet to come to much of the world and LNG prices make oil look like the liquid diamonds.

A new era of low oil prices thanks to ever increasing technologival innovation and desperation on the part of petro states - justhow the West wanted it.

15 comments:

Anonymous said...

@ A new era of low oil prices thanks to ever increasing technologival innovation and desperation on the part of petro states - justhow the West wanted it.

Lots of desperation, lots of oil, lots of migrants.

Blue Eyes said...

Happy days. Many sensible people expect oil to be obsolete long before it runs out.

Also, maybe time for George to invoke the "stabiliser"? Especially with the glut in diesel encouraging people to give everyone lung cancer.

Does the internet law where a post on any topic attracts comments about house prices or immigration have a name?

Bill Quango MP said...

That's another Blogpost.

the different reporting of the same story across the UK newspapers.

Migrants being a fun one.

_ Daily Express - Migrant driver could have killed Diana
- Mail - Migrant swarm lowers house price in Bordeaux.
- Mirror - Uncaring Tories compare low income arrivals to insects

etc

James Higham said...

Wonder how much of this was to hit Russian oil and gas.

Nick Drew said...

well I am a consumer & I know where my interests lie!

Gazprom et al certainly in deep doodah

http://blogs.ft.com/nick-butler/2015/08/09/russia-in-trouble-as-energy-prices-fall/
http://www.theguardian.com/world/2015/aug/07/gazprom-oil-company-share-price-collapse
http://www.ft.com/cms/s/0/4ac1cdd6-3f79-11e5-9abe-5b335da3a90e.html#axzz3iRelzeIE

rwendland said...

>Plus the cost of drilling shale have already been absorbed, you may as well pump it.

I thought with a shale field you had to continually re-drill to maintain production, as each well's output declined quite rapidly. I thought a single shale well's production usually dropped by between 35% to 50% over the first year.

So with "(light) tight oil" or LTO, as oil from shales is called, you have to continually re-invest to maintain production. So production will gradually fall away if prices are too low to support this re-investment.

Have I got this wrong?

CityUnslicker said...

rweneland - not entirely but the costof the initial seismics, permitting and drilling (and the raising of financing for this) is the really expensive bit. The constant re-working is costly but it not in the same order of costs as the commissioning phase - plus with technology impvorements abounding in the US, drilling LTO costs have droppped 50% in 3 years with the rate continuing.

It was said Shale was only profitable with oil crude at $80, now it is $60....in a another 2 years this may well be $45-50.

hovis said...

Again CU to an extent, the thing about the shale plays is that it depend on how much of a "sweet spot" is hit so the geology determines output ar more than in a convenional well. There will no where near as much stable output even with re-fracking and re-drilling (even from and existing multi well pad.) So fall off of productiono on average means new well every 2.5 years compared to a 20 - 30 year lifespam of a conventional well. Given that they are having to redrill to maintain production this remaisn a problem. Shale in the US has only been kept alive by ZIRP and a the dash for yield making ponzi schemes seem attractive. As to costs continuing to fall - let us see - it is still not a money making proposition.

hovis said...

...though I agree they will continue to pump due to need to finance debt repayment and costs are sunk which is why there continued to be an increase in production in the US as the oil price has cratered. Interesting to see what happens should demand stay weak as I would expect over the medium term.

rwendland said...

CU, yes, I guess the front-end costs could easily dominate.

This guy has stats and graphs showing that the number of drilling rigs in operation in the major US fields have dropped to about half over the last 9 months or so, which I think he says is derived from EIA numbers. But he does say producers hold drilled, but unstarted, wells "in stock" - so they may not have reduced the rate of starting new wells yet. His graphs suggest around an 18-month lag from changes in rig count to production output changes.

But there seem to be many contrary views in this field, so it is hard to come to any firm conclusion on what is happening. Some say the US shale producers are struggling to service/re-finance debt at the current oil price, so are reducing costs. But I certainly don't have a good idea if this is true.

But it seems like the big OPEC countries (maybe just Saudi) are trying to drive LTO producers out of business with low prices. If US producers are indeed cutting back on drilling, maybe Saudi will ease back on the price pressure?

rwendland said...

... off course if the drill count has halved, that will reduce drilling costs a lot as the contractors drop prices to maintain business.

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