America is not an oil swing producer, says energy economist

10% is not enough compensation for American capital just now – Hirs

Rex Tillerson says the American shale oil sector has become the world’s swing producer, able to rapidly ramp up production in response to supply shortages. The Saudis, French supermajor Total, and energy economist Ed Hirs beg to differ.

Tillerson – CEO of ExxonMobil, the world’s largest listed oil and gas company – told the Oil & Money conference Tuesday that shale producers’ resilience in cutting costs to make some wells profitable at as low as $40 a barrel means that North American production has effectively become a swing producer, according to Reuters news agency.

“I don’t quite share the same view that others have that we are somehow on the edge of a precipice. I think because we have confirmed viability of very large resource base in North America… that serves as enormous spare capacity in the system,” said Tillerson .

“It doesn’t take mega-project dollars and it can be brought on line much more quickly than a 3-4 year project.”

Saudi Arabia’s Energy Minister Khalid al-Falih countered that market forces are “clearly working,” fundamentals are improving, and the market is re-balancing.

“On the supply side, non-OPEC supply growth has reversed into declines due to major cuts in upstream investments and the steepening of decline rates,” he said. “Without investment, that trend is likely to accelerate with the passage of time to the point that many analysts are now wending warning bells over future supply shortfalls and I am in that camp.”

Total CEO Patrick Pouyanne, says he expects supplies to fall short by 5 to 10 million b/d by the end of the decade after investments in the sector dropped from $700 billion two years ago to $400 billion this year.

“I know that the shale oil industry is very innovative and they have cut costs and adapt but we won’t be able, if we continue this way, to fill the gap,” Pouyanne said.

Pouyanne and al-Falih are right and Tillerson is wrong, says Hirs, who teaches economics at the University of Houston and is also the managing director of Hillhouse Resources, a small producer in the Niobrara play.

“I think that the ExxonMobil position that the US shale plays are the swing producers is incorrect on several levels,” he said in an email to North American Energy news.

One, Hirs says the “wipe out of capital” in the shale plays will make any recovery a slow process.  Capital providers who are not in ExxonMobil’s “envious capital position are very skittish about going back into high cost plays.”

“One only has to note that ExxonMobil has no significant presence in the shale plays to understand that the economics are not sustainable or that there are better alternatives in the oil patch,” he said.

Two, ExxonMobil’s statement that $40/b can work really relies upon $40/b at the wellhead and does not account for survivorship bias: that is, those shale play companies that are left were ones who could produce at a profit when the average marginal cost was between $51 and $60/b in 2012.

“Those who were producing above the average are the ones who are gone now.  While $40/b typically assumes a 10 per cent return on investment, 10 per cent is not enough compensation for capital just now,” said Hirs.

Three, shale oil production is a discrete, step function and not a continuous function.  The US is not a “swing” producer that can dial up or dial down production at its own discretion.

“The shale plays need a higher price in order to be brought back into the money,” said Hirs.

“At the peak of shale oil production in the US, 22,000-plus wells were producing almost 5 million b/d.  To regain that rate of ever increasing drilling to make up for the shale well declines will require a rapid rehiring and deployment of capital.

Hirs notes that Saudi Arabia produces 9-plus million b/d from only 3,300 +/- wells.