Why $100 Oil Won't Be Coming Back for a Long Time

A growing consensus is emerging from the likes of BP Plc, the International Energy Agency, shale wildcatters and even the Saudis that a near-term recovery to $100-a-barrel crude isn’t in the cards. Instead, expect a range of $50 to $60 for at least the next few years.

When oil prices plunged sharply in 2008, they rebounded almost as quickly. Several months ago, industry and government touted the same U or V-shaped recovery this time out. On closer examination, a new factor in the marketplace -- shale oil -- has changed their minds.

“This is the new normal,” Dennis Cassidy, co-leader of the oil and natural gas practice for consulting company AlixPartners, said in an interview. His group sees an L-shaped chart that could extend for three to five years.

Unlike other petroleum formations, the nature of shale -- with multiple inexpensive, short-lived wells -- means producers can stop and start drilling on a dime. On the one hand, this allows them to quickly cut costs in a downturn; on the other, every time prices tick up, so will their output -- renewing downward pressure on prices.

While an offshore well usually costs about $100 million to drill, and takes as long as 10 years and billions more to begin producing from a new field, a shale well requires only several million dollars and a few weeks to coax out oil and gas.
No Coordination

“When the price of oil recovers, most shale formations will be aggressively exploited,” said Leonardo Maugeri, a former Eni SpA vice president and now a researcher at Harvard University’s Belfer Center for Science & International Affairs. Based on his appreciation of shale’s special qualities, he predicted the current glut in 2012.

No central authority tells shale drillers, who have been described as the new “swing producers,” what to do. Unlike the Organization of Petroleum Exporting Countries, the effect they’ll have in holding down prices comes from a set of independent decisions influenced by the need to deliver shareholder returns.

The expectation that U.S. producers will boost drilling as soon as prices improve is why oil executives, including BP Chief Executive Officer Bob Dudley, are saying they don’t see $100 a barrel returning for a “long time.”

Chesapeake Energy Corp. and Oneok Partners LP are among companies basing their budgets on an assumption that oil will stick to about $50 to $55 a barrel this year, with $65 the ceiling for next year.
Gas Echo

The current oil market is an echo of the 2012 natural gas crash, in which shale producers inadvertently created a glut that hasn’t yet been resolved. In that instance, even after prices fell to the lowest level in more than a decade, gas output continued to grow, according to data from the U.S. Energy Information Administration.

That reflected the industry’s ability to adapt to lower prices by improving productivity and reducing expenses, said Bloomberg Intelligence analysts Vincent Piazza and Gurpal Dosanjh in a report this month. Market observers who see historically higher costs as proof of an eventual decline in oil should “appreciate the industry’s experience in cost cutting,” they wrote.

After sinking to a low near $44 a barrel in January, crude prices have hovered around $50 in recent weeks, rising and falling a few dollars on the latest comments from OPEC members or government reports on drilling activity, production and inventories. U.S. crude rose less than 1 percent to $49.92 at 8:58 a.m. in New York.
Found Bottom

This is not the first ever L-shaped recovery. Talisman Energy Inc. CEO Hal Kvisle compared the current downturn to the late 1980s and early 1990s, noting that oil prices spiked briefly during the first Gulf War and then stayed around $20 a barrel through most of the rest of the decade as global production peaked from Alaska to Russia to Saudi Arabia.

A similar range of between $70 and $75 could occur now for many years, Kvisle told reporters Feb. 18.

“We’ve probably established the bottom of the range now, and we’ll see prices generally trend upwards, but I don’t think things are going to go upward in a dramatic fashion,” he said.

Just 10 years ago, surging demand in developing countries and increasingly difficult-to-get oil resources combined to push up crude prices on fears of running short. After briefly plunging below $40 during the 2008 recession, prices have traded mostly above $80 a barrel, and often above $100 for the past five years.

Those higher prices helped pay for the technology and innovation needed to develop U.S. shale fields and Canadian oil sands, leading to a North American production boom that’s now created an oversupply of oil as growth in global demand faltered on a weakening economic prospects in Europe and China.
OPEC’s Control

During boom and bust cycles since the early 1970s, a powerful OPEC, the cartel of oil-producing countries led by Saudi Arabia, coordinated output among its 12 members to raise and lower world crude prices. This time, it has refused to act to prop up prices, insisting that it’s up to U.S. shale producers to make the cuts needed to rebalance the market.

That was a startling change from several decades ago, when the majority of the world’s oil produced outside of OPEC countries came from projects such as offshore developments in the U.K.’s North Sea, requiring vast investments in new technology and pipelines to wring crude from hard-to-reach deposits.
Shale Dominance

Production from shale-rock formations makes up about half of total U.S. output, which also includes offshore projects in the Gulf of Mexico and wells drilled in past decades. Unlike the giant gushers behind previous oil growth, the shale boom was driven by thousands of new wells that could be drilled quickly and relatively cheaply, but faded fast after an initial burst of production.

The steep falloff in well output that was perceived as shale’s key weakness is proving to be an advantage in the downturn. With fewer new wells drilled to make up for declines, production will tail off faster than when the world relied on traditional wells.

“Shale has attributes that make it nimble. It is proving very responsive to prices,” said Jim Krane, an energy fellow at Rice University’s Baker Institute for Public Policy in Houston. “There are low barriers to entry, but also low barriers to exit. Other, conventional producers cannot do this.”
‘Swing Producer’

The flexibility to increase or slow output quickly has now made shale companies -- whose 4.3 million barrels a day represents about 5 percent of global output -- the world’s “swing producers,” according to Bloomberg Intelligence and the IEA.

It was a role they took on reluctantly -- and then ferociously as prices plunged late last year. U.S. oil companies slashed more than $50 billion from their spending and laid off tens of thousands of workers as prices continued a freefall and investors began to flee. The market value of U.S. shale companies has fallen by more than $200 billion since June, according to data compiled by Bloomberg.

“We’re not interested in growing oil, when oil is at the bottom of the cycle,” William Thomas, Chairman and CEO of EOG Resources Inc., the biggest U.S. producer focused on shale, said at a Credit Suisse Group AG energy conference Feb. 25. “We’re deferring growth until future years and prices gets better.”
Needing Growth

Stalled growth is not a story investors like to hear, so shale companies are walking a fine line between holding down costs and reassuring shareholders that they can turn the spigot back on as soon as prices recover. In comments Feb. 19 about fourth-quarter profits, Thomas talked about cutting drilling in half and also emphasized, “We will be ready to respond swiftly when oil prices improve and resume our leadership in high return oil growth.”

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