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Drillers push to develop Alaskan oil

Roger-Rabbit-icon1The U.S. oil industry wants to drill in Alaska, and to justify this, they argue the shale oil will run out in a decade. (Click here for source.)

They’re probably right on the latter point. The fracking bonanza almost certainly is temporary. Conventional oilfields, such as those in the Middle East, and the Texas and California oil basins, can produce for 50 to 100 years. In addition, early pumping methods left a lot of oil behind, and better technology and higher oil prices extend the life of those fields.

Fracking is fundamentally different. While a conventional oil well typically has a decline or depletion rate of 2% to 4% a year, fracked wells have very steep decline rates, often 80% in the first year. Although America’s shale basins contain a lot of oil, the frackers have to keep drilling new wells to get it. And while domestic fracking production has grown very rapidly, from almost nothing a few years ago to several million barrels a day now, this industry and these fields will “flame out” equally rapidly. So enjoy abundant fracked oil while it lasts, because it ain’t gonna last very long.

There are big pictures and little pictures when you talk about oil. For a rural family that depends on well water drawn from an underground aquifer for farm and household consumption, a fracker’s shoddily lined borehole that leaks natural gas or toxic chemicals into the groundwater is such a big problem it dominates every waking minute of their lives. But in big picture terms, that’s a highly localized, little-picture issue. It acquires some big-picture dimensions when a state like New York bans fracking altogether because state authorities lack confidence in drillers to exercise sound drilling practices and in their own ability to adequately regulate those who do not.

But when I say “big picture,” I’m referring to these things, in no particular order:

1. The world runs on oil.

2. It will continue to do so for our lifetimes.

3. The world still has plenty of oil, but the supply isn’t infinite, and it’s probable that human civilization and economies eventually will run on electricity instead of fossil fuels.

4. Although burning fossil fuels is bad for the environment and human health, and is causing destructive and costly climate change, we’ll probably continue using fossil fuels until they’re gone, regardless of what that does to the planet or us. If you don’t believe that, this book explains why, and its last sentence describes our ultimate fate.

5. Saudi Arabia probably is lying about how much oil they have left, and how long they can keep supplying 10% of the world’s oil demand. It’s very likely they have less oil, and the end is nearer, than they’ve led us to believe. These estimates are state secrets in that country, and rank among the world’s most carefully guarded secrets, on a par with Israel’s nuclear capabilities. Why? Because oil is worthless in the ground, so the Saudis want to sell every barrel they have, and if their customers see the end coming and develop replacement energy sources, the Saudis will get stuck with millions or billions of unmarketable barrels. Their interests are best served by lulling the world into complacency until one day they abruptly announce, “Sorry, guys, that’s it — we’re dry.”

6. The smart thing for the U.S. to do is import as much oil as possible, and leave our own oil in the ground as long as possible, so we’ll be the last man standing. But that’s very hard to sell politically. Achieving near-term energy independence, so we can tell OPEC to stuff it and avoid paying oil bills, feels a whole lot better. The way to do that is pump like crazy. But we’ll pay a steep price in the future for what feels good today. Our bargaining position is much stronger when we have oil in the ground than it’ll be when we don’t.

7.  Despite falling oil prices, fracked oil is not being priced out of the market, because fracking costs are falling even faster. There was a learning curve that kept costs high initially, but frackers are figuring out technology improvements and operating efficiencies that are reducing their costs. A year ago, the average cost of a barrel of domestically fracked oil was about $62, but today some frackers can profitably sell oil for $40 and a few say they could do so at $30.

8. Oil prices won’t rebound quickly. U.S. oil production will keep rising for at least another year, no matter what the market pays for oil. The reason is that most of the cost is invested upfront, before any oil is produced, and once you’ve spent $12 million on a well you have to pump that oil or go broke. If your choice is between selling that oil for $6 million or leaving it in the ground and getting $0 for it, you’re going to pump it even if you lose money, because it’s better to lose $6 million than $12 million. U.S. drilling activity is falling off a cliff; rig counts are down two-thirds since last fall. But until all the wells already drilled run dry, U.S. oil production will keep rising, because that money has already been spent and it costs almost nothing to run the pumps. Given typical fracking depletion rates, it will take at least a couple years to drain those wells. Then, if oil prices remain low, U.S. production will fall off a cliff.

9. Another thing to know about the U.S. fracking industry is that the majors aren’t very involved and most of these new gushers have been brought in by small companies — hundreds of them. And most of these companies financed their drilling and operations with junk debt. Many of those companies are facing bankruptcy and a lot of those bonds will default; the amount of this debt (about 18% of the total junk bond market) isn’t large enough to trigger another 2008-type financial crisis, this is much less money than was put at risk in questionable subprime mortgages, but once these companies are gone they won’t produce oil anymore. Sure, they’ll be replaced by other companies who will pick up the production slack, but just be aware that the U.S. fracking industry is in turmoil, with much of it facing financial collapse, and this resource won’t be exploited smoothly going forward. Fracked oil will come out of the ground in burps, grunts, and belches, with interruptions. That’s not a prescription for smoothly functioning oil markets or stable oil prices.

10. Fracked oil isn’t the most expensive oil, and won’t be the oil forced off the market by low prices. That honor belongs to deep sea oil, arctic oil, and heavy oil (such as that on which Keystone XL’s economic viability depends).

11. When you read in news stories that certain countries “need” oil prices of $100 or more, that doesn’t refer to their production break-even costs; it means they need that much to fund their social spending. This is important because, in most cases, that spending buys social peace. We’re probably going to see riots in Venezuela soon, followed by a government overthrow and military junta. But that won’t happen in Iran; the ayatollahs have too firm a grip on the military and society. In Russia, where oil revenues fund half of government spending, the oil squeeze makes Putin more dangerous because it threatens his ruling power. He’s distracting the populace by wagging the dog.

12. Finally, what’s the best way to put America’s fracking windfall to good use? This one’s easy. It can buy us time to move closer to a post-oil economy. But you and I both know we’re not going to use it that way. Just look around you. Gas guzzling pickups and SUVs are selling like hotcakes once again. Happy days are here again.

 

 

 


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