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Shale and Petroleum – The Big Picture (Part 3)

Shale and Petroluem - The Big PictureIf you have not done so already, you’ll want to read Part 1 and Part 2 of this series first, before delving into this final Part 3.

So, now that we know that this “shale revolution” has at least been a short-term game changer, it’s time to get into some more specifics of how unconventional oil sources should impact our long-term perspective. On that point, let’s first turn to Mathilde Mathieu, Oliver Sartor, and Thomas Spencer, research analysts at the think tank Vox CEPR’s Policy Portal, whose recent article “Economic analysis of the US unconventional oil and gas revolution” is quite informative. Their view is that the U.S. shale gas boom is not as much of a “revolution” as one might think. Yes, it has accomplished all the things mentioned in the earlier installments of this series, in the face of declining conventional oil production, “But it is not a panacea.” They assert that

Even if current estimates of shale oil production turn out to be accurate, the benefits to the US economy in the long run are relatively small, and the benefits to manufacturing competitiveness in most sectors are even smaller. In the longer term, US energy security and climate goals will still require a strong role for public policy frameworks. Improving energy efficiency and promoting low-carbon technologies will be just as important as before. For the EU, given its more limited known reserves of unconventional oil and gas, these conclusions are likely to be all the more relevant.

The point is clear: with shale and tar sands we have simply bought more time. But it should be kept in mind that the additional time we have bought is not a mere extension of the prior status quo. While we are continuing to develop a comprehensive alternative energy plan, we have to monitor the wild card effects from having introduced unconventional oil to the market. For an immediate example, we need look no further than the current global oil price drama: although shale and tar sand production have helped satisfy demand, their saturation in the market appears to have overstepped what the Saudis are willing to tolerate. Now, they are clearly pushing back, and instead of lowering their production, and encouraging the rest of OPEC to scale back so that aggregate world production is more in line with world demand, they are deliberately over-filling the market in order to push prices down. One of the apparent goals of this downward price pressure is to keep North American shale and tar sand producers from obtaining the $75 – $85 per barrel minimum price they need to stay in the black. Already, that caveat of being “more expensive” to produce is becoming a major factor for unconventional oil producers. They need higher prices to stay viable.

On the flip side of this price stability issue, we should also keep in mind that upward spikes in price are not necessarily the greatest thing for unconventional producers either–if oil prices shoot up too high then all the other cost inputs for production start to follow along with it. And so this is the rub. These more expensive oil sources clearly favor a more stable price environment, but by their nature they make it harder to maintain that price stability.

Trying to look on the bright side for a moment, can’t we just appreciate that temporary lowered fuel costs are good for the economy? Can we at least expect continued lower fuel prices for a while now because of shale? Leonard Brecken of OilPrice.com posted his thoughts on this issue a few weeks back on April 10. He focused on two key issues: 1) that an increase of U.S. imports during a lower price environment/U.S. storage glut indicate that short-term depressed U.S. consumer prices are actually welcomed by the U.S. (for the time being); and 2) that long-term depressed prices, despite the fact that they’re being assumed by many analysts now all the way into 2018, go completely against the interests of the U.S. and its allies. In fact, such continued low prices “would essentially bankrupt most of OPEC, US conventional oil, part of US shale and deep offshore drilling.” Will we all impotently stand by and watch that happen? As a Texas oilman might say, “That dog don’t hunt.”

Already in the works is the free market adjustment that inevitably comes in these market downturns–rigs are continuing to be taken offline, production will be reduced, and at some point (assisted by an increase in demand triggered by lower prices) supply will drop enough for prices to start trending back up. Boone Pickens underscored this in the very same interview discussed in Part 2. Just like in 1981, 2001, and 2008, this will happen as the industry will always seek self-preservation. Hundreds of rigs have already been taken offline in recent weeks. After all, how much drilling can petroleum and shale producers afford to do in such times of lowered revenue? How much can producers afford to essentially cooperate in allowing lower prices to prevail (through contributing to over-supply)? How much of their finite reserves accessible from the rigs already in place can they afford to let go of by selling into a low-priced market?

Moving beyond basic considerations of supply and demand, let’s now add some other pertinent observations to our high-altitude perspective, starting with the ever-critical global political landscape. Do we see regional conflicts and civil unrest receding in the near future? Even the most optimistic among us are not counting too heavily on world peace and global brotherhood taking hold as we cooperate together to share equally and fairly in the dwindling supply of petroleum, that cheap, easy-to-access, conventional oil. Conflicts and tensions abound at the doorstep of great oil producers, if not directly in their back yard—Russia, Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela all immediately come to mind. And oil infrastructure is a valued target for terrorists—anyone projecting a decline in terrorism going forward?

But what about technological developments—can we at least expect some relief from them? Won’t we benefit by new technology that allows us to accomplish more with less energy? Well, certainly in terms of living standards, convenience, and economic growth. Not so much, however, in terms of managing our finite resources. This is because the general tendency for humans is that whenever technological breakthroughs allow us to use an energy resource more efficiently we respond by expanding the application of that technology, resulting in an overall increase in demand for the underlying energy source. This was famously observed by William Stanley Jevons in relation to the use of coal at the beginning of the industrial revolution, and it is known as “Jevons’ paradox.” Demand for a fuel is increased through a “rebound effect,” and in the absence of a special tax designed to limit any growth in demand, the rate of resource depletion will rise even as the amount of resource consumed for accomplishing the same work has dramatically fallen. So, we certainly will want to plug that into our calculators too.

Oh, and how could we forget? There will undoubtedly be ongoing pressure upon governments to reduce carbon emissions or somehow capture them and minimize their environmental impact. By the same token, we may continue to see an increase in pressure to require cleaner and safer processes for extracting unconventional oil sources—i.e., at an even greater expense than already being incurred. And we may experience future costs in environmental cleanup related to past production and use—hopefully for genuine solutions to genuine problems (not like the con artist who tried to convince Jed Clampett on The Beverly Hillbillies to invest in that gigantic fan he was supposedly going to put at the top of the mountains overlooking Los Angeles to blow out all the smog).

All kidding aside, however, there should be serious concern regarding this point, as demonstrated by the recent developments in Alberta, where new regulations have been approved requiring environmental cleanup and reductions of waste water related to tar sands production (in response to public outcry about production-related pollution). (See this March 13 Bloomberg article for more on that.) U.S. shale has its own problems, as well, with the California fracking industry and its regulators coming under a firestorm in recent months for what the L.A. Times reported as being “corrupt, inept and woefully mismanaged” oversight that allowed for unacceptable levels of benzene and other toxic waste to flow into its coveted aquifers from hundreds of wells. Not very good timing for this, considering California’s well-publicized water shortage problems. (And not a very good “P.R. Moment” for the fracking industry in general as the public is also getting riled up about the volume of water consumed in California for fracking—by some estimates, the annual equivalent of two additional major cities.)

Well, folks, we certainly have a lot to consider here. In the final analysis, oil is energy, energy is work, and work is food — the ultimate energy. And money is only as good as the energy it can buy.  Thus, the production of petroleum, shale, and other sources of energy will continue to serve as the centerpiece of our economic concerns for years to come—until that time when we (fingers crossed) really do innovate our way out of it. These truths don’t have to be a pill that is too bitter to swallow, however, if we have the right attitude. With the right gracefulness, as A. Whitney Brown tried to demonstrate in his “The Big Picture” segments on Saturday Night Live’s “Weekend Update,” we can acknowledge it, deal directly with our challenges, and come out the better for it in the end.  And when it comes to global oil production, that means dealing squarely with the elephant in the room: given a world of increasing demand, or even flat demand, oil must get more expensive.

And that, my friends, is the Big Picture.

About Brad Daniel

Brad Daniel is a Director at BMC Group, an information management firm specializing in financial and legal transaction support. He has 25 years of restructuring experience, with a broad exposure to all aspects of bankruptcy case administration and reorganized-company/trustee support. His expertise in both bankruptcy legal matters as well as systems integration and rapid application development…

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Brad Daniel