Is US shale oil discovery the main reason for decline in global oil prices?

The decline in crude oil prices has once again humbled our forecasters. How quickly the prices have declined from $100 plus levels to $50 levels and continued to decline is amazing. There are many reasons suggested for the decline and major one being  US shale oil revolution. People say due to shale oil, US has become a net supplier of crude oil in the world and this has dampened prices.

Prof. Lutz Kilian of Michigan Univ, an oil expert has a different take on the shale story:

Only a few years ago, many observers expected a steadily growing global shortage of crude oil. This shortage did not materialise in part because of the rapidly growing production of shale oil in the US. The production of shale oil (also referred to as tight oil) exploits technological advances in drilling. It involves horizontal drilling and the hydraulic fracturing (or fracking) of underground rock formations containing deposits of crude oil that are trapped within the rock. This process is used to extract crude oil that would have been impossible to release by conventional drilling methods designed for extracting oil from permeable rock formations. Shale oil production relies on the availability of suitable drilling rigs and skilled labour, which is one of the reasons why the US shale oil boom so far has been difficult to replicate in other countries.

US shale oil production has grown from about 0.4 million barrels a day in 2007 to more than 4 million barrels a day in 2014. This expansion was stimulated by the high price of crude oil after 2003, which made the application of these new drilling technologies cost competitive. The expansion of US shale oil production soon captured the imagination of policymakers and industry analysts. By 2012, the International Energy Agency projected that the US would become the world’s leading crude oil producer, overtaking Saudi Arabia by the mid-2020s and evolving into a net oil exporter by 2030 (International Energy Agency 2012). Pundits envisioned the US becoming independent of oil imports, net oil exports financing the US non-oil trade deficit, and consumers enjoying an era of cheap gasoline with a resulting rebirth of US manufacturing. My recent research, however, suggests that these visions remain far removed from reality (Kilian 2014).

There are risks with the world view:

To gauge the importance of shale oil for the US economy it is useful to bear in mind that, as of March 2014, shale oil accounted for almost half of US oil production, but only about a quarter of the total quantity of oil used by the US economy. This magnitude is far from negligible, but to understand the excitement about shale oil one has to consider projections of future US shale oil production.

Publicly available projections of future shale oil production have to be interpreted with some caution.

One concern is that increases in shale oil production are not permanent.

Sustained production requires ongoing investment. Projections by the US Energy Information Administration suggest that even under favourable conditions US shale oil production will peak by 2020 (at a level commensurate with US oil production in 1970) and then decline. Moreover, even the peak level would be far below what is needed to satisfy US oil demand.

A second concern is that estimates of the stock of shale oil that can be recovered using current technology are subject to considerable error.

In the summer of 2014, for example, the Energy Information Administration was forced to lower its previous estimates of the stock of recoverable shale oil by 64%.

A third concern is that it is not known how vulnerable the shale oil industry is to downside oil price risk.

This concern has become particularly relevant in recent months with the rapid decline in global oil prices. Shale oil production remains profitable as long as the price of oil exceeds marginal cost. There are indications that the initially high marginal cost of shale oil production has been declining substantially, as the shale oil industry has gained experience, but there are no reliable industry-level estimates of marginal cost.

In short, there is considerable uncertainty about the persistence and scope of the US shale oil boom, and there are many reasons to be skeptical of the notion that the US will soon (or indeed ever) become independent of oil imports.

Plus, the two oils are not substitutes:

Even more importantly, the shale oil debate has largely ignored the fact that shale oil is not a perfect substitute for conventional crude oil, making comparisons across countries difficult. The quality of crude oil can be characterised mainly along two dimensions. One is the oil’s density (ranging fromlight to heavy) and is typically measured based on the American Petroleum Institute (API) gravity formula; the other is its sulphur content (with sweet referring to low-sulphur content and sour to high-sulphur content). Figure 1 provides an overview of how commonly quoted crude oil benchmarks (including West Texas Intermediate (WTI) and Brent oil in the North Sea) can be characterised along these dimensions. Shale oil consists of light sweet crude (at most 45 API), ultra-light sweet crude (about 47 API), and condensates (as high as 60API). Thus, not all shale oil is a good substitute for conventional light sweet crude oil such as the WTI or Brent benchmarks, and an aggregate analysis of the crude oil market tends to be misleading. In reality, the impact of shale has been far more complicated

So keep expectations lower….

Who and when prices rise people will latch onto what Prof Kilian has to say..


One Response to “Is US shale oil discovery the main reason for decline in global oil prices?”

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