Oil Market Outlook : The Fat Lady Has Started To Sing
In a traditional manufacturing process you will produce your output as long as you are making a positive cash flow on the sales of your products and as long as there are no lack of input factors. One can say the same for the shale oil industry. As long as there are enough resources available and as long as the oil produced can be sold with a positive cash flow, the oil will be produced. Decline rates might not mean that much in such an industry. You drill and move on as long as you have acres available. The lead time from investment to first oil could be as short as a year for these shale oil projects. It is not like the offshore oil industry we know from Norway for example which demand large, irreversible investments and where you will not see any positive cash flow until many years ahead.
Since the lead time from investment to cash starts flowing in is so short in the shale oil industry, maybe it is more reasonable to see the investment as operational cost instead of capex? It almost becomes like refining. If the margin disappears you throttle back output to save operational costs, but you quickly ramp up if the margin comes back. Why would decline rates be important in an industry with such a short lead time? Every drilled well can be seen as operational costs rather than capex and you just drill and move on and drill and move on as long as the resources are there. The rig used for drilling the well does not have to be left there while the well produces. Hence the question is rather if you believe the resources are there to a large enough extent that the production growth can continue. We believe the resources are there.
For Norway the danger of this new industry is that it will be a competition to produce our barrels cheaper than what the Americans can do. If the break even price for shale liquids production in the US drops to lets say a 45-65 $/b range and the Arctic barrels we believe we have in the Barents sea requires 90 $/b to see the final investment decision, the Norwegian barrels might be competed out of the market. There might not be any need for these barrels. The best example of such a situation in real life is what happened to the Shtokman project. The gas from Shtokman basically became unnecessary to produce after the US shale gas revolution.
Eoin Treacy's view Veteran subscribers will be familiar
with the refrain at Fullermoney that unconventional oil and gas is a game changer
for the energy sector. This report helps to emphasise that point by illustrating
the extent of unconventional resources and the impact they are already having
on the price of energy and on decisions to invest in new supply.
An old commodity market adage is that the cure for high prices is high prices. Over the last decade, the supply response has been somewhat muted. However, what is now becoming clear is that there are vast energy resources available for development if the price is right. Following the 1970s oil spikes, prices never fell back to pre-spike levels. The same is probably going to be true of the current decade long bull market. Just about all the new supply expected to reach market in the next decade depends on a higher cost of production than conventional oil. If prices fall too much, that new supply will be shuttered. The other side of the equation is that oil prices in excess of $100 are likely to remain an inhibitor to economic growth which should act as a drag on the ability of prices to sustain rallies.
While these represent important macro themes, the more immediate concerns are of a short-term political nature. Brent crude failed to sustain the break below $90 in June and has rebounded to retest the upper side of the range near $120, where it has at least paused. A short-term overbought condition is evident and a clear upward dynamic would be required to question current scope for at least a consolidation of recent powerful gains