Low Oil Price May Stifle Deepwater Drilling And Oil Sands But Not Fracking

Saudi Arabia and OPEC may have dropped oil prices to stifle production in the U.S. and other competing nations, but they didn't drop it enough to stifle the U.S. oil and gas boom from fracking, a senior expert with McKinsey and Company said in Chicago.
"If the Saudis think they're going to put U.S. shale players out of business, they're probably not, although there will be less drilling," Joe Quoyeser told about 125 people, mostly graduate students, at Northwestern University's Kellogg School of Management Energy Conference on Wednesday. "But there are other elements of oil supply that are needed to balance the market that will have a hard time competing at $50 a barrel, including oil sands in Canada and much of the deepwater resources."
Oil sands have to be heated to extract petroleum, a process that requires natural gas. Even at today's low gas prices, that fixed cost means oil sands only become viable at about $75 a barrel or more, Quoyeser said.
Beside the inherent costs of drilling at depth, deepwater drilling faces increased regulatory oversight since BP's Deepwater Horizon disaster in 2010, which delays revenues. (And in fact, on Feb. 25 Moody's downgraded Transocean's credit rating to junk status.)
"We think these need prices on the order of $75 to $80," said Quoyeser, who advises petroleum executives on hydraulic fracturing, lateral drilling, deepwater strategies and supply chains.
Yet U.S. crude oil production continued to rise in February, according to the Energy Information Agency, thanks largely to fracked shale wells.
Oil prices dropped more than 50 percent since June. The largely unpredicted drop was caused neither by demand shock—like the drop in consumption that occurred during the Bush economic collapse of 2008—nor by supply shock—like the fall of the Shah of Iran in 1979, Quoyeser said, but by chatter.
"Our view is that OPEC and the Saudis talked this market down. This was a rhetorically driven price adjustment."
Why would they do that? Because with oil above $100 a barrel, a lot of new players were entering the oil business, including Iraq, Lybia, and fracking operations in North Dakota. At the same time, the oil price was so high that it constrained the growth of emerging markets.
"Saudi Arabia, as a long term resource owner, their interest is that the demand for crude oil continue to grow."
The Saudis and OPEC faced fast-growing supply and sluggish demand, which left them with an unattractive future.
"Our view is that they'd rather take the pain now than take the pain later," said Quoyeser, who called it "a very profound short-term pain" for Saudi Arabia, a loss of about $500 million per day.
Saudi Arabia could recover those losses by decreasing supply by a million barrels per day, but it hasn't.
Quoeyeser expects the Saudis to eventually act to balance the market as they have in the past, which means manipulating the price back up to about $75 to $85 per barrel, where oil sands and deepwater drilling can again participate profitably, but not so high that many more suppliers enter the market.
Even so, he predicted, the supply side will remain dynamic. Fracking operations, among the least mature of drilling technologies, have the best opportunity to make it more dynamic, he said, particularly if they begin to employ "smart fracking" technologies, which will help drillers locate productive shale resources before they drill.
"If the industry becomes much more efficient at using seismic technology to lower the cost of accessing light, tight oil, that has the potential to put downward pressure on oil prices."
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