Prices and potential

Oct. 13, 2014
If prices of crude oil continue to slide, oil production in the US very likely will follow. Naysayers then will claim vindication for their gloom about supply from unconventional resources. For a while, they'll seem right.

If prices of crude oil continue to slide, oil production in the US very likely will follow. Naysayers then will claim vindication for their gloom about supply from unconventional resources. For a while, they'll seem right.

Since the year's high points in mid-June, when terrorist violence surged in Iraq and Syria, spot crude prices are down as much as 22% for Brent and 16% for West Texas Intermediate. Now, fear about the spread of Middle Eastern disruption has given way to concern about a faltering global economy. With demand flagging, oil supply continues to rise from North American resource plays and from members of the Organization of Petroleum Exporting Countries jockeying for market share. The dollar is strong. Until something changes this mix of forces, oil prices will be inclined more to stumble than to climb.

Fragility in focus

A deeper price swoon would bring fragility of the North American supply boom into focus. Especially with low-permeability reservoirs, where production declines typically start early and steepen quickly, sustaining output requires continuous drilling and completion of wells. That costly work is sensitive to the oil price. Because costs vary between and within plays, and because drilling in some areas is driven by lease obligations, an activity decay, if it happened, would be uneven. But it would be inexorable as the crude price descended below profitability thresholds.

In a period of drilling suppressed by price weakness, production of oil and gas liquids from low-permeability reservoirs might be as surprising on the way down as it has been on the way up. But declarations about the supply boom's end, sure to arise in such a production slide, would be premature.

Unconventional-resource plays have not changed the economics of oil. The current price sag reflects oversupply, much of it having developed because the North American supply surge has been strong enough to offset losses in troubled OPEC members. A market correction was inevitable. But corrections work in both directions.

The nature of production from shales and other tight formations, with its pronounced early-year declines, should compress the cycle. A sharp drop in total output represents a quick cure for oversupply unless demand, in defiance of the price decline, falls equivalently. Price recovery thus can be quick to materialize, perhaps quicker than in markets of the past. If this proves true, drilling and production should rebound quickly as well. In unconventional plays, operators know where the resources are. And they won't forget the tantalizing volumes if they do have to trim operations while prices are low.

Reasons thus exist to expect cycle periods to be shorter in a market increasingly dominated by tight-oil plays than they have been in conventional environments. Reasons also exist to expect tight-oil plays to endure long past activity fluctuations associated with price cycles.

Today's economics assume today's technology. In tight-oil plays, technology progresses rapidly as operators optimize drilling and completion strategies while service and supply providers improve fluids, proppants, downhole tools, geophysical methods, and myriad other elements of the ever more-complex work to which the categorical description "horizontal drilling with hydraulic fracturing" doesn't do justice. In nearly every play, production performances improve, and estimated ultimate recoveries increase, with each new well.

Long-term potential

Learning impressively as it works and improving the work as it learns, the industry still has barely tested the supply potential of oil locked by extremely low permeability in continuous reservoirs. Recovery factors in most tight-oil plays remain in single digits. Only the lightest liquids are flowing. Enhanced recovery is just beginning to be tested. Enormous volumes of oil remain in place, which operators don't have to risk capital trying to find. And the industry is assembling an asset likely to gain value as technologies advance: a network of holes in extended contact with oil-bearing rock.

A decline in tight-oil production thus might loom as oil prices droop. But it will indicate nothing about long-term potential, which remains spectacular.