Last year I had the opportunity to begin teaching again, and in doing so I asked every class to predict the chance that oil would fall below $100 a barrel and the chance it would fall below $50 a barrel.
Through August nearly all of the class participants under the age of 50 said that there was “very little” to “no” chance of oil selling for less than $100 and “impossible” for oil to sell at or below $50. Only those above the age of 50 were willing to say
“most likely” to oil being sold below $100 and “likely to even chance” to oil hitting $50.
Yet here we sit, after four years of a narrow band of oil prices from $105-$120 a barrel, with prices now close to $50 a barrel.
This is hardly the first time the oil industry has seen such a rapid drop in the price of its benchmark product. In recent history look at 2008 for the biggest gyrations, but also look at the drops of 1999 and 1983.
Thus in my career I have seen, so far, four major price “shocks.” They are to be expected – although we seem to be caught off-guard each time they occur.
There were others before these – but if we ask, as the industry always asks, “Why?” we are often given the short term, or tactical answer; that is, what is driving this particular price fall.
I would like to take a step back and look at a larger picture to draw some conclusions that should provide, if not a roadmap, then at least a type of guide for the future.
For a quick reminder, when oil was $12 a barrel in 1999 we, as the industry, just wanted oil to rise back to $20 a barrel (or about $45 in 2014 dollars).
The global oil market is both a perfect long-term supply and demand market with no one player or cartel able to control commodity prices, and yet a short-term inefficient market often controlled by emotion and herd mentality.
At best, there usually appears to be a global best efforts finding and development cost for new oil that moves with technology and service prices that during some periods OPEC can influence oil prices to just below that current level in order to slow, but
not eliminate, research into new technology that can lower the overall F&D costs.
Eventually however, there will be a new breakthrough in technology that will lower F&D costs per barrel – and thus, there will be an increase in oil production. OPEC can then either lower production to maintain price or keep production to keep market share
but allow price to fall.
That is where we find ourselves now.
In a perfect world these price swings would play out over the months and years that it actually takes for the full impact of the technology to be felt. However, today most oil production is bought and sold through commodity markets and financed on the margin. This
has led to investors working harder and harder to get further and further ahead of the production curves – and often getting caught out when the swings start back the other way.
These future calls, derivatives and hedges cause the price gyrations to be larger and much more extreme than warranted.
In 2008 oil traders heeded warnings of “Peak Oil” and drove oil prices up to record prices of over $140 a barrel, which helped precipitate the global economic collapse – and then panic selling six months later drove the price to just below $35 a barrel.
The world supply and demand system did not move that much out of kilter – in fact, there was less than 5 percent change in the supply/demand curve. Within months oil price was back in the $70 barrel range, where it was before the gyrations began.
Based on that experience, I expect that oil prices will rebound to the $80-90 barrel range within six months and be somewhat higher later in the year.
Herein lays my point: Over my 35-year career I have witnessed three incredibly disruptive innovations in the oil and gas industry that have required major adaptations for the industry to survive.
♦ The first was the Digital Revolution. Remember, 35 years ago all logs were printed on paper at the well site, plus on film. There was no 3-D seismic and no computers. Communication was done by office visits, landline telephones,
facsimile or telex.
But now, the ability to store, manipulate, visualize and work with digital data in 3-D space has allowed a generation of earth scientists to understand and to discover more oil and gas in the last 30 years than in the preceding 100 years – yet at a time
when it is much more difficult to find oil and gas deposits now, because most of the easy big fields have been located.
This has led to oversupply issues and the price collapses in the 1980s and ’90s.
♦ The second disruptive innovation was the ability to explore and produce in the deep marine environment.
Thirty-five years ago 300 feet of water (100 meters) was considered close to the limit of technology. Today Shell is developing the Stones field in 9,500 feet of water (2,900 meters) in the Gulf of Mexico, and there are deepwater exploration and/or development
wells around every continent except Antarctica.
Currently over six MMboe/d are being produced from deepwater wells, primarily from the Gulf of Mexico, Latin America (Brazil) and Africa.
Yet deepwater basins are still considered frontier areas with a very low drilling density and there are many untested basins. The deepwater oil production ramped up from about 1.5 MMboe/d in 2005 to just over four MMboe/d in 2008, just as the world economies
crumbled in the largest economic crisis in over 50 years.
Thus this oil success story became partly a victim of its own success.
♦ The third disruptive innovation is the Unconventional Revolution, or using the combination of several technologies (horizontal drilling, hydraulic stimulation, pad drilling) to economically produce gas and some liquid hydrocarbons
from very low permeable formations previously thought to be far too “tight” to ever be commercial.
Generally known in the press as shale gas or “fracking,” these unconventional reservoirs trap the hydrocarbons by capillary forces – not by traditional buoyancy forces – and demand a different style of evaluation and development.
Although horizontal drilling, stimulation and pad drilling all have been used for over 50 years, it was the application of all three applied to the low permeability reservoirs that created a disruptive innovation – and has altered U.S. energy markets.
Starting with the shale gas drilling in 2008, the industry has oversupplied the U.S. gas market and dropped the price of gas from $7/btu to a current $3.40/btu, and has saved the U.S. economy approximately $200 billion since 2008.
U.S. liquids production which hit an all-time high of 10 MMBbl/d in 1971, declined to a low of 5.3MMBb/d in 2008 before unconventional drilling has brought it back to over 9MMBbl/d in 2014 (EIA).
Thus, this disruptive innovation added almost 4MMBbl/d of liquid production to the world market in 2014 as the European, Chinese and Indian economies announce major slowdowns.
The short-term market reaction should not have been totally unexpected – but expecting the price to likewise stay below $70 a barrel does not appear to have any basis.
It remains to be seen how resilient unconventional operators will be, but current analysis indicates that this rapid price swing can be disruptive to some of the overleveraged and some of less efficient operators.
Most of the better operators will weather the price storm in good fashion and continue their innovation learning curve.
The real test will be to take these innovations and apply them to formations outside of North America. There are multiple tests under way in Latin America, Europe, Australia and China, but to date none have reached truly commercial scale.
Oil and gas currently are essential commodities for modern life, but subject to market demands and the eternal fluctuations in supply and demand.
It is important to try to keep a larger view on the big changes, those disruptive innovations, which demand a change in the way we do our business.
Each one of the disruptive innovations of the past 30 years began with existing technology and built on it; each one started on the fringe and grew until it became dominant.
None started from scratch as a “change the world” idea, but in time each did just that.
There will be new and different innovations, and it is difficult to predict where they will come from. There are several new applications of technology with the potential to radically change our business, from wastewater to nano-technology.
Anyone who predicts the future by not anticipating radical changes will repeat the mistakes of the past. We are an innovative industry – so go disrupt things!
Keep it turning to the right.