Shale Oil Pessimism Could Be Overdone

The press is now full of articles about the p

Watford City, North Dakota, Oil production in the Bakken shale formation near the Missouri River. (Photo by: Jim West/UCG/Universal Images Group via Getty Images)

UCG/Universal Images Group via Getty Images

eaking of shale oil production and the meaning for the oil market and global economy. The majority of these appear driven by the recent decline in drilling in the Bakken, Eagle Ford and especially the supergiant Permian shales, as the figure below shows. And as so many note, shale wells have very high decline rates, implying that production needs continuous high levels of investment to avoid dropping, and that reduced drilling could mean a rapid decline in output.

This combination of factors has resulted in headlines this year like “Peak Permian? Geology and Water Say We’re Close” Peak Permian? Geology and Water Say We’re Close | OilPrice.com “US oil output has peaked amid price fall, top shale producer warns” US oil output has peaked amid price fall, top shale producer warns and “Peak Shale Amid Maximum Pessimism” Peak Shale Amid Maximum Pessimism. These and other articles typically focus on the drilling efforts and the possibility that the economics don’t justify enough investment to keep increasing production. Some argue that the constraint is more geological than economical, but others focus on comments from industry executives who see rising costs and weak prices as the primary constraint.

Which suggests that while shale oil production might plateau or even decline in the near-term, the trend would not necessarily be irreversible. A big part of the problem is the readiness in some quarters to interpret production weakness as permanent, even when it would seem to be driven by sharply lower prices. This was very much the case after the oil price collapse in 2014/15, at which time several sources insisted that the drop in shale production was permanent. For example:

“US shale oil too expensive, peaks 1H 2015” US shale oil too expensive, peaks 1H 2015 published in September 30, 2015; “This report finds that tight oil production from major plays will peak before 2020.”Drilling Deeper: A Reality Check on U.S. Government Forecasts for a Lasting Tight Oil & Shale Gas Boom – Post Carbon Institute October 27, 2014; “The decline in the existing wells might be so large that we in reality will have peak shale oil in 2015.” Shale oil production will level off and we will have a peak in the oil production in 2015 | Aleklett’s Energy Mix January 28, 2015

What actually happened? Shale oil production dropped by about 0.5 mb/d after oil prices dropped, as the figure below shows, but then nearly doubled in subsequent years even as drilling remained depressed. True, the fact the pessimists were wrong before is hardly proof that they will be wrong again. Yet the specific mistakes behind their errors are informative. The biggest lesson is that it is nearly always possible to a datum, quote or anecdote to support pre-existing biases.

Thus, industry executives fretting about challenges and investors decrying poor financial returns are misinterpreted as evidence of insurmountable physical obstacles. A reduction in drilling and/or slowing of production growth is assumed permanent and irreversible, one noted pessimist saying recently “shale can’t outrun geology forever.” Interestingly, the story he linked to was more about low oil prices causing drillers to exhibit caution, “Oil executives are taking these Texas sayings to heart and are being cautious, preferring not to make any sudden moves in their drilling programmes until crude prices recover.” US shale companies tighten their belts amid oil price uncertainty

The rise in popularity of the Hubbert curve in the 1970s and again in the 2000s involved a tendency to treat geology as the dominant, and sometimes only, factor driving production. Prices spikes were treated as evidence of geological scarcity, even when a political disruption of supply was clearly at fault. Additionally, there was a tendency to assume static technology especially by extrapolating past drilling results into the future.

But this approach repeatedly fell victim to the cleverness of the geologists and petroleum engineers, who wage a never-ending struggle against depletion. As colleague Trisha Clark, President and CEO of Petronerds, Inc., put it a 2015 working paper for the Oxford Institute of Energy Studies:

“Companies are in fact doing more with less: cutting costs and getting higher initial production per well. Drilling and completion costs have come down considerably as the service sector discounts services to try and retain market share. Efficiency gains have proved stronger than anticipated and are a result of a number of factors, including better equipment, reduced drilling times, better use of horsepower, and an overall acute awareness of the need to cut costs.” WPM-62.pdf November 2015

And the actual post-price collapse behavior is informative. The previous figure showed aggregate production which resumed growth after the price collapse, even with a fraction of the previous drilling activity. The figure below shows how rigs active in the Bakken dropped from 180 in September 2014 to 24 in May 2016, before recovering to roughly 50 afterwards. Production, which had been growing sharply, initially fell by about 250 tb/d, or about 1/5^th, but then began growing again almost as much as before, even though drilling was only 1/3 pre-price collapse levels. Post-pandemic, production has been flat even with much lower levels of drilling as pre-pandemic and especially compared to the level before the price collapse in 2014.

Forecasters and pundits tend to be very wary of predicting advances in drilling technology and methods, part of a more general reluctance to make assumptions about the future. Can drillers improve efficiency forever? Can new methods substantially reduce costs and/or raise productivity into the future? Such uncertainty is important to recognize, but should not mean discarding all expectations of future progress.

As an example, the figure below shows just one factor affecting shale economics, the number of wells drilled in a month per rig active in three basins. There is clearly improvement, something on the order of one-third more wells per rig over the past five years, albeit not in the sense of a constant flow of progress, as other factors muddy the results.

Nonetheless, observers should remain aware that the industry has overcome challenges including low prices, in the past and is likely to see more progress in the future, even if the precise methods or results cannot be predicted. Where shale oil production goes from here is more dependent on oil prices and costs than geology, especially in the medium-term future. And while the industry might at some point find itself unable to overcome geological constraints, that, as Damon Runyon would say, is not the way to bet.