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With Shale, 'Increasingly Unlikely' World's Oil Reserves Ever Exhausted, Says BP Economist

The "core beliefs" that many energy economists had about the global oil markets have been upended by the U.S. shale revolution, BP plc's chief economist said Tuesday.

Spencer Dale argued for an updated set of principles to reflect the new economics of oil on Tuesday before the Society of Business Economists Annual Conference in London. Two things, he said, are having a profound impact on the future of the energy markets: the shale revolution and concerns about carbon emissions.

"The emergence of shale oil, together with growing concerns about climate change and the environment, means that the beliefs that many of us have used in the past to analyze the oil market are out of date," he said. He argued that:

  • Oil is not likely to be exhausted and no presumptions should be made that the relative price would necessarily increase over time;
  • Unlike conventional development, shale is more responsive to price, which should act to dampen price volatility;
  • Oil is likely to flow increasing from west to east; and
  • OPEC should remain a central force and will continue to serve as a temporary buffer to supply-demand.

The total stock of recoverable oil resources was assumed to be known, but in practice, "estimates of recoverable oil resources are increasing all the time...far more quickly than existing reserves are consumed," Dale said. For every barrel of oil consumed, another two have been added over the past 35 years and today are almost 2.5 times more than in 1980.

As supplies have increased, another market changer has emerged even stronger -- growing concerns about carbon dioxide emissions and climate change. That growing issue means "it is increasingly unlikely that the world's reserves of oil will ever be exhausted."

Increasing energy supplies and a push toward climate change policies suggest is that "there is no longer a strong reason to expect the relative price of oil to increase over time," Dale said.

There is an assumption that the relative price of oil may increase over time as supplies become more difficult and costly to extract. However, the increasing difficulty is likely to be met with technological progress as innovations continue, he said.

"Productivity gains within the U.S. shale industry in recent years have been mind-boggling...Productivity growth, as measured by initial production per rig, averaged over 30% per year between 2007 and 2014."

Today, unconventional drilling is more akin to a standardized, repeated manufacturing-like process, rather than the one-off, large-scale engineering projects that characterized conventional projects, the BP economist said.

Dale also took to task the principle of oil demand-supply curves. Several years may lapse between initial investments and production ramp ups. Shale development has turned that notion on its head.

"First, the nature of the operation in which the same rigs and the same processes are used to drill many wells in similar locations means the time between a decision to drill a new well and oil being produced can be measured in weeks rather than years," Dale said. "Second, the life of a shale oil well tends to be far shorter than that for a conventional well: its decline rate is far steeper."

Daily production from a typical Bakken Shale oil well may decline by as much as 75% in its first year of production. The corresponding rate of decline for a well in the Gulf of Mexico is much slower.

"These two characteristics -- short production lags and high decline rates -- mean there is a far closer correspondence between investment and production of shale oil," Dale said. "Investment decisions impact production far more quickly. And production levels fall off far more quickly unless investment in maintained."

The short-run responsiveness of shale development to price changes would be much more than for conventional development. As prices fall, investments and drilling activity in unconventional fields decline with production falling soon after. As prices recover, so too would investment and production on a faster scale.

The high rates of decline in shale wells also mean that operating costs are a "relatively high ratio of total costs." The high decline rates in effect mean that shale operations have relatively low fixed costs.

As in all economic theory, there are some murky points. A big change factor is the nature of the shale producers versus the "traditional," old money oil majors.

"Although its production characteristics should dampen price volatility, the financial characteristics of the independent producers operating in U.S. shale may introduce an additional source of volatility," Dale said.

Conventional production is dominated by national/international oil companies but even the largest U.S. shale operators have "far less robust" financial resources. The higher exposure of shale producers to the financial system "means the oil market is more exposed to financial shocks."

Also evolving is the long-held principle that oil flows from eastern markets to western hubs, i.e., from the Middle East to Europe and to the United States.

However, oil demand in the West has been falling for about 10 years now. And the United States quickly is becoming energy independent. Citing BP's most recent Energy Outlook 2035, Dale said the United States should become self-sufficient in energy by the early 2020s and in oil by the early 2030s (see Shale DailyFeb. 18). Those energy flows in turn will shift west to east.

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