Shale Oil vs. Arctic Drilling
The Death of Shale
Last month, the suits over at Shell (NYSE: RDS-A) put on their sad faces and went to the White House to ask for more time to burn through another billion or two.
I tell ya, these guys are gluttons for punishment.
After eight years and more than $6 billion, Shell has come up completely empty on its promise to bring a bounty of Arctic crude to market from the Chukchi Sea.
The plan to tap this Arctic flow was devised more than a decade ago — before the U.S. was swimming in shale oil and before consumption rates started falling.
Certainly I don't fault management for moving aggressively on black treasure in the Arctic. At the time, it made a lot of sense. But today, with $80 crude, a boom in domestic oil and gas production, and little chance of ever successfully producing anything more than losses in the Chukchi, Shell really should just chalk the whole adventure up to an unfortunate face-plant and move on.
That's not to say Arctic drilling is a wash. After all, the Russians continue to leverage their Arctic assets to ink major deals with China, and Norway's Statoil ASA (NYSE: STO) claims its discoveries in the Barents Sea can be profitably developed with oil trading below $80 a barrel.
Of course, Norway is also desperate to stop its 13-year decline in production, so certainly there's a bit of urgency for Statoil to produce a field that some believe holds 40% of the country's undiscovered reserves.
Still, it should be noted that the first field scheduled for production is already looking at cost overruns in excess of 50%. This doesn't bode well for future developments — at least not with oil trading below $80.
Fortunately for Statoil, this won't last long.
3 Inconvenient Truths About Shale
Although you will get plenty of arguments from other analysts, I maintain that current oil prices are merely a blip.
I don't buy for a second that OPEC has the ability to play a long game of chicken, and I'm also of the belief that the shale revolution, which has completely disrupted the global market, doesn't have significant staying power.
As I've discussed in the past, the full impact of decline rates is rarely discussed when investors gather around to throw shale parties and wax poetic over illusions of century-long production runs throughout the United States.
In fact, a new report authored by Canadian geoscientist J. David Hughes (a 32-year veteran with the Geological Survey of Canada) argues that the government's entire forecast for tight oil and the shale boom is severely flawed because it doesn't take into account three inconvenient truths:
- High productivity shale plays are not ubiquitous, and wells suffer from very high rates of depletion.
- Because depletion rates are so high and drilling locations increasingly unproductive, the industry must drill ever more wells just to offset declines.
- To continue drilling rates, the industry will need prices to rise substantially or have to take on more debt, which may not be sustainable.
Hughes concludes that 89% of current tight oil production in the U.S. will peak this decade and decline to a small fraction of current production by 2040.
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So What's This Mean?
It means the shale party could come to an end a lot sooner than many are anticipating.
But the way I see it, there's still plenty of opportunity to milk this thing for everything it's worth — especially now, while oil prices are low and there are plenty of bargains to be had.
It also means that in another 10 to 20 years, perhaps the longing for Arctic oil will be met by economics that make it viable.
But for now, I don't expect Shell to get much love from the Obama administration. And even if the company does get an extension on its lease, that doesn't mean it will be successful.
Continued lawsuits and equipment malfunctions could end up being a much better facilitator of failure than a thumbs-down from the president.
To a new way of life and a new generation of wealth...
@JeffSiegel on Twitter
Jeff is the founder and managing editor of Green Chip Stocks, a private investment community that capitalizes on opportunities in alternative energy, organic food markets, legal cannabis, and socially responsible investing. He has been a featured guest on Fox, CNBC, and Bloomberg Asia, and is the author of the best-selling book, Investing in Renewable Energy: Making Money on Green Chip Stocks. For more on Jeff, go to his editor's page.
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