The Texas driller and the shale oil industry

The price of oil has been falling steadily, reflecting the stalling world economy. A further destabilising factor has been the boom in shale oil production, particularly in the United States. PETE MASON reports.

"Good morning from the dog house on a cold, wet Friday in South Texas", an experienced oilfield driller, whose username is Mike, posts to a peak oil website. "I am below $50 this morning after severance taxes which means most folks are as well, unless hedged. The mood out here is bleak and a lot of hands are being told rigs will be stacked by February in very significant numbers. So goes the drilling part of it all, goes all other oilfield services and it is not good. People are very worried". (Peakoilbarrel.com, 18 December 2014)

The two largest shale oilfields in the USA are the Eagle Ford, Texas and the Bakken, North Dakota. In the last three years, production here has shot up, while the rest of the world’s oil production fell slightly. While oil prices were high, the US oil industry claimed that extracting shale oil, using the dirty, expensive method called fracking, would make the US a new Saudi Arabia and end the declining global oil supply. But gloomy prognostications about the world economy have been reflected in falling oil demand worldwide, and the surplus US shale oil production caused prices to fall in June 2014.

But by October shale oil production growth in the Bakken had stalled. As of November it is flatlining. And the number of wells fracked had fallen by three-quarters by November compared to September. Record-breaking rises would have been expected. The US oil revolution is shuddering to a halt. December figures will not be out until mid-February, but total net US oil imports, including petroleum products, which had fallen to a new low of 4.6 million barrels a day last winter, rose to seven million barrels a day during November-December 2014. If sustained, this off-the-chart rise would soon push up the price of oil, all other things being equal.

In the meantime, tax breaks are approaching for oil companies in the Bakken – triggered when the oil price falls below $52 over five months. The heavily discounted price of oil in North Dakota was just $29.25 in December. Reuters calculates (22 December) the tax break will amount to a "$5.3 billion, two-year tax gift" for the oil companies, leaving the state with only $2.9 billion in oil taxes.

North Dakota tries to ensure the oil companies have an easy ride – literally. The state has trebled its spending on roads, as they are destroyed by 28-wheel trucks carrying oil from 8,400 shale wells. The fracking process requires as many as 1,000 truckloads of water and sand for every well. Together with the 40,000 gallons of chemicals, some carcinogenic, truckers completed between 2-4,000 trips a day in the Bakken in October just to complete the fracking, let alone transporting the oil. In Texas, where the Eagle Ford shale ‘play’ produces about one million barrels every day from 11,000 wells, one county alone needs $2 billion in capital investment for the roads. (Crumbling Roads in Oil Fields Slow US Energy Boom, Bloomberg, 11 July)

Running to stand still

Water and sand are in short supply. Wisconsin alone ships the equivalent of 9,000 18-wheeler trucks of sand a day to the fracking industry. Power stations are running out of coal because cheap shale oil is "jamming the railways", reports Bloomberg (18 December), forcing the price of electricity up to a 15-year high. The oil companies, those swaggering bastions of capitalism, thrive in a state-backed paradise of hand-outs, subsidies and favouritism. Increasing incidents of illegal dumping of radioactive waste by oil companies encouraged the state’s department of health to propose a tenfold increase in the allowed limit of radioactivity in landfills, so that oil companies can landfill their radioactive waste legally. Up to 75 tons of radioactive waste, mainly radium which occurs naturally in the fracked shale, is produced daily in North Dakota. (Williston Herald, 13 December)

All this madness results from the poor productivity and rapid decline rate of shale oil wells: a 60-70% fall in oil in the first year of production, according to the Economist (6 December). Norwegian oil worker and peak oil writer, Rune Likvern, calls it the ‘Red Queen’ effect, from Lewis Carroll’s Alice Through the Looking Glass: "It takes all the running you can do, to keep in the same place". If production is to increase, new wells have to be drilled in ever-increasing numbers. It is costly and uneconomic at current prices. Additionally, new wells drilled today are not as productive as the original ‘sweet spots’ were, and production is down by as much as a third for new wells.

Exxon executives do not see it that way. Bloomberg news reported: "Crude oil production from US wells is poised to approach a 42-year record next year as drillers ignore the recent decline in price pointing them in the opposite direction... So far, the Organisation of Petroleum Exporting Countries’ month-old bet that American drillers would be crushed by cratering prices has been a bust". (Exxon Mobil Shows Why US Oil Output Rises as Prices Plunge, 8 December) The logic behind the Panglossian picture is simple: "Companies that are already producing oil will continue to operate those wells because the cost of drilling them is already sunk into the ground". Oil wells have ‘$25 or less’ operating costs, so low prices will not undermine operations.

So why is Bakken oil production growth slowing down rapidly? Because of the 60-70% decline of existing shale oil wells. Once drilling new wells declines, production stalls and eventually also declines. Natural Gas: The Fracking Fallacy, an article published in the science magazine Nature argues that the USA, "banking on decades of abundant natural gas to power its economic resurgence", may be engaged in nothing but wishful thinking (3 December). The same applies to fracking oil, as the same dynamics apply.

Oilfield driller Mike is "sitting behind the mud pumps on an empty five-gallon bucket" waiting for orders. He writes: "My industry has spent the past seven years coaching a new team of qualified personnel to develop these stupid shale plays. Now I am afraid that we might lose a lot of those men and women next year. I hope not forever. Over a million jobs have been created by the shale oil industry; you gotta be dumb as a box of ball bearings to not understand the significance of that. And you have to be as uncaring as a cedar fence post to not care".

Cutting back production

ExxonMobile has one last card to play. "Chairman and CEO Rex Tillerson pledged in March to raise output by an annual average of 2% to 3% during the 2015-2017 period". That would "arrest a two-year production slide", Bloomberg reports (18 December). In reality, even before the oil price collapse, Exxon announced capital spending cuts of 6.4% in 2014 after peaking last year. (Wall Street Journal, 5 March 2014) Big independent oil companies have seen a five-year decline in oil production, now falling 5% a year, despite a five-fold increase in capital expenditure. Recently, they began cutting spending and turned to other projects such as gas production, which has been expanding. They have generously let the small players take the hit in the shale oil play.

The BBC reported (21 December) on an oil summit in Aberdeen where one panicked executive claimed that North Sea oil production was "close to collapse". North Sea oil rigs use gas to force the remaining oil out of depleted reserves. As the number of rigs declines, the gas supply from rigs within range is lost, and production can collapse. The development of high-cost deep-sea production in Brazil and elsewhere is being undermined. Russian oil production hit a new peak in 2013, but government officials declared (Tass, 7 July) that it will begin to fall from 2015 onwards as no new projects could arrest the decline of mature fields.

The Saudi ruling elite claim to be simply letting the market decide the price of oil, and have so far refused to cut production. Ironically, it is the US capitalists who are desperately hoping for market manipulation by OPEC – as long as the USA does not have to sacrifice market share. But with the partial exception of Saudi Arabia, OPEC members have generally been pumping all the oil they can for many years, irrespective of targets. Now, Saudi Arabia refuses to be the fall guy. The US government seems to have lost influence, perhaps an adjunct of the ‘post-Iraq syndrome’ since the war of 2003 which has left the region in ruins.

No profits, lots of debt

"The shale oil industry has not made a stinkin’ nickel of profit yet", writes Mike. "Not one penny. If we were in the level of debt those guys are, with their revenue cut in half the past three months, we would be looking to take long walks off short piers into shark infested waters". Shale production may tumble because a quarter of shale oil companies are over their heads in debt, the Economist concurs. Many have misjudged their hedge against falling prices, leaving them vulnerable to losses at current prices. The bloodbath in this huge industry threatens contagion in the wider economy, unless a government bailout prevents it.

"Shale accounted for at least 20% of global investment in oil production last year", the Economist reported (6 December 2014). "Total debt for listed American exploration and production firms has almost doubled since 2009 to $260 billion... it now makes up 17% of all America’s high-yield (junk) bonds. If debt markets dry up and profits fall owing to cheaper oil, the funding gap could be up to $70 billion a year".

Will lack of supply force prices back up later this year, if US shale oil production falls sharply and the rest of the world’s oil production continues to fall? The Saudi Arabian government thinks it will. If its budget assumes an $80 average price of oil for 2015, as some reports argue, that means oil at $100 average for the second half of 2015 to balance a $60 price in the first half.

The US economy has benefitted from the fall in oil prices. Europe, Japan, China, and other net oil importers, whose economies have been weakening or falling into recession, could see gains, possibly boosting demand. But other countries are adversely affected, and if the USA’s junk bond bubble bursts, with possible contagion worldwide, there may be a further depression of oil demand. Then there is the drop in world demand in the advanced capitalist countries, associated with more fuel efficiency, movements to cheaper coal and gas, and finally to environmentally friendly carbon-free technologies.