Sunday, 30 August 2015


City Wire, 26 August 2015

James Phillipps
Shale oil is undergoing an unheralded productivity boom – the scale of which has not been seen since the early days of IT – that will depress oil prices for a generation.

That is the stark view of Neptune head of research 
Chris Taylor, which has led his firm to minimise exposure to the oil majors across its fund range.

Oil bulls are admittedly a rare breed in the current climate, with recent moves in the futures market signalling that the price will recover much more slowly than many have predicted. The Black Monday sell-off saw oil prices sink to a six-year low and down to levels not seen since the height of the financial crisis. WTI slumped to slumped to $38.24 while Brent dived to $42.69 and few are prediciting an imminent strong rebound.

However, Taylor believes even current prices may be too optimistic as investors continue to focus on legitimate global growth concerns, but underestimate and misunderstand the massive advances being made in horizontal drilling.

‘If you think about traditional oil, they have been pulling it out of the ground for around 150 years so they know what they are doing and can squeak out productivity gains of around 2-3% a year,’ he said.

‘Shale oil only really started in 1998, in any meaningful way, and we are seeing massive productivity gains, which can be as much as 20-30% a year and they can maintain that level for longer than people think.’

Taylor points to the hard numbers in Exxon’s first quarter report as an indicator of just how stark productivity growth has been. In an update on its US Bakken shale oil field, Exxon revealed its return on investment per $1,000 spent has grown from 12.5% in 2011 to 40% in 2014, which is equivalent to a 321% rise. This has resulted in a collapse in the field’s breakeven rate from $115 a barrel in 2011, down to $35.8 in 2014.

‘A 321% productivity gain over four years is incredible. I have never seen an industry move like this since maybe very early IT at the beginning of the PC rollout and it hasn’t even finished yet,’ Taylor said.

‘This is the biggest ever supply side disruption. The incremental supply increases are not only big by anyone’s standards, they are an overwhelming supply disruption and the beauty is it’s onshore, so cheap and easy to turn off
and on.’
Rigs down, output up
The surge in productivity has resulted in a collapse in the number of rigs in use, which Taylor believes has hoodwinked many investors.

The rig count hit an all-time high of 1,600 at the start of the year, but this number has since collapsed by 43%, yet output has continued upward.

This echoes a similar pattern in gas extraction when the rig count ‘spookily’ peaked at 1,600 in 2009 before collapsing by 58%. Although the number stabilised over the next three years, it has since shrank by a further 64% and Taylor expects a similar pattern with oil.

The slump in the gas price to around $2.8/BTU has exerted further pressure on the cost of oil. Historically, owing to oil’s higher calorific content, it was priced around eight times gas, but if this metric is used, then oil has much further to fall.

‘If gas is at $4, then oil should be nearer $32, not $45 and gas is nearer $3.’

He said such is the glut of US supply increase, its productivity gains were the fourth highest ever by a single country in 2014 and the 10th highest in 2013, with the 2015 figures yet to be factored in.

The US added 1.5 million barrels per day last year and 1.3 million in 2013, which is of such a magnitude that it is sufficient to more than fill the gap in production left by much of Libya and Iran being offline.

‘Historically, supply side disruptions have been very big and instant [for example, through war], but the US productivity gains are not only big enough to offset it very quickly, they can exceed it. This gives you a better ability to dampen out volatility and oil price swings, and structurally the oil price must track lower,’ Taylor said.

‘Another problem the oil price has is that if you look at shale reserves globally, they are massive and very well spread. The likes of Argentina and China have not even started, and long-term, when they get going, there will be a massive amount of supply coming through.

‘You are going to see relatively cheap and abundant hydrocarbon resources for some time yet, with US shale fields alone not expected to peak until 2040. That is a generation of cheap supply.’

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