Will the world stay awash in oil?

In late October, when the oil prices were in the beginning of their recent decline, I came across a very optimistic opinion on shale boom future in the Wall Street Journal. “The Oil Price Swoon Won’t Stop the Shale Boom,” tried to convince his readers Mark P. Mills, a physicist, Manhattan Institute senior fellow and co-author of “The Bottomless Well” (Basic, 2006). He passionately advocated shale oil technologies and reached a crescendo in the final paragraph with “…and the world will stay awash in oil.” God forbid.

To qualify Mills' claim, we need first to learn how the oil shale economics works. Shale companies are reluctant to show the entire value chain, but we know at least these several things about their business[1]:

  1. High capital expenditures: about $10 mln per well;
  2. Quick payback. 40% of the recoverable oil can be pumped in the first 1 to 4 years;
  3. Production plateau plummets sharply afterwards. Meeting the estimated ultimate recovery requires constant drilling and fracking. But it doesn’t matter – you can sell the acreage if you are satisfied with the first bulk of revenue.

Lots of newborn oil industry players were attracted by this economics. Thanks to the quick payback shale business perfectly fits small independent oil companies: they secure a short- to mid-term loan or issue bonds, invest, drill and pay off. But does this scheme fit crisis times? Not really.

The high-yield debt that US shale industry is dependent on is essentially the kind that is reserved for small, risky assets. And this is also the kind that is first to disappear if something goes wrong in industry. Something like oil price. Credit is already withdrawing from the sector, and small companies will feel it first.

It doesn’t mean that shale oil industry will die within few months, but it means it ought to change. I would expect a wave of acquisition and merges to happen early next year, which would lead to redistribution of assets from small independent companies to oil majors with actual money on bank accounts and diversified assets. These guys, the global top companies, like to see oil price steadily growing, while fuel – reasonably accessible. Will then the world stay awash in oil?

  1. Ivanov N. Shale America (2014) Moscow: Magistr ↩︎