Oil Prices and Saudi Arabia’s Big Bet
So far it has cost Saudi Arabia something like $200 billion to undertake one of the most expensive experiments of all time. The Saudi government has been draining its massive $2 trillion sovereign wealth fund to cover revenues lost from the petroleum price collapse over the past couple of years.
Nothing is Bigger Than Oil
But before delving into all that, some underlying realities: This is no small battle. Oil is the world’s biggest traded commodity, bigger than all the minerals and metals combined, bigger than agriculture. And despite decades of hype, hope and subsidies, petroleum fuels 95 percent of the machines used to move all people and all goods for all purposes, trade included. The world today uses more oil than at any other time in history and every forecast—including a recent lamentation about this reality from the International Energy Agency—predicts demand will increase for the usefully foreseeable future. And of deep geopolitical relevance, of the world’s five economic regions that account for 75 percent of global GDP—Europe, China, India, Japan and North America—four of them will see rising dependency on petroleum imports. North America, especially the United States, is the outlier with exactly the reverse trend.
Big Gambles, Big Risks
This big gamble by the Saudis made sense considering that, unlike the traditional oil business, the shale hydrocarbon industry is so new, barely a decade old, and there is no history to go on for predicting price-response behavior. And because the shale ecosystem is made up of thousands of small and mid-sized enterprises, the biggest of which are a fraction of the size of the super-majors, there is no easy way to get “into the heads” of the operators to predict behavior, unlike the long history of generally predictable responses from big-company executives.
The results of the first part of the experiment are now known. Over the 30 months of declining prices, the number of shale drilling rigs in operation collapsed nearly four-fold, and about one-third of the companies in the shale business went bankrupt or became seriously financially distressed. And shale oil production did decline; but so far only about 12 percent off the 2015 peak. Meanwhile, even during the glut-induced financial storm, shale technology just kept getting better. Average productivity—the amount of oil produced per rig—was up 20 percent last year alone, while drilling costs stayed flat or declined slightly.
The lesson from the first half of the experiment is thus clear: A price drubbing achieved only modest production declines and did nothing to slow and arguably accelerated the radical technology gains in the cost-effectiveness of shale drilling. Put another way, the Saudis have seen that the amount of money needed to add more American supply keeps shrinking and is moving monthly closer to the Middle East’s vaunted low-cost advantage. At the current tech-driven growth rate, output per rig will double every 3.5 years. That kind of progress is normally seen in Silicon Valley. For consumers it’s exciting, but not so much for shale’s competitors.
Bounce Back in Shale Production
Now comes part two of the experiment. As prices creep back up—an inevitability as world demand keeps growing, while global investments in production have everywhere pulled back in the face of low prices—just how quickly will American shale production rise this time? We know the answer: fast. We’re about to find out just how fast. The number of oil rigs nationwide peaked in October 2014 at 1,609 and then fell rapidly to 316 in May 2016 as oil prices collapsed. The number of drilling rigs then increased by 150 percent to 789 by March 17, 2017. Given how much more productive today’s rigs are, it won’t take much more of a rig count rise to produce world-shaking results.
Given what we know from very recent history, it’s reasonable to think that the shale industry today could grow again at least as fast as it did from its inception, circa 2005, when shale companies went on to more than double U.S. production in a handful of years. And that happened using technology that was literally half as good as what exists now, and with operators who then had to learn on-the-fly to use techniques for which there was no prior experience. That industrial ecosystem now has fantastically better technology, deep experience and a pre-built infrastructure. One might pay attention to what shale pioneer Harold Hamm, Continental Resources founder and CEO, said earlier this year about U.S. oil production: “We’ve doubled it. We can double it again.”
Sand and data are the greatest drivers of oilfield innovation and value in the 21st century. Without sand, or more generally proppant as displayed in the bottles above, there is no hydraulic fracturing, and without hydraulic there is no opening of tight oil and gas plays like the Bakken region in North Dakota. With modern well logging techniques drillers can mine massive amounts of data faster and in more detail to find statistical correlations among huge datasets in the blink of an eye.