US Shale and The ‘Energy Freedom’ Myth

Three-and-half kilometres below the Earth’s crust lies one of the hottest oil-producing sectors in the world right now.

The 250-million-year old Permian Basin, located in the US state of Texas, has been driving the second phase of the US shale oil boom since 2014.

The idea of an energy-independent US first arose around 2008, when the latest technology was applied to hydraulic fracking. Unlike traditional oil drilling, fracking is a process in which highly-pressurised liquid is fed into a well to fracture the rocks where hydrocarbons like oil and gas rest.

The intense pressure bursts open the rock, pushing the oil and gas out and up and into the well.

It’s not a new process. The US first experimented with it back in 1947. However, advancements in technology eventually made fracking affordable, which has driven its popularity. But, more importantly, frackers can drill horizontally as well as vertically. Meaning it can reach the shale oil and gas traditional oilers can’t.

More below…

In the past four years, land values in the Permian Basin have risen rapidly, all thanks to the second wave of the shale boom. In 2016, the average plot sold for US$25,000 (AU$31,870) per acre. Earlier this year, however, oil explorers paid as much as US$60,000 (AU$76,480) per acre. That’s a stunning 50 times higher than the price of a plot from four years ago.

US-based Bernstein Research suggests it won’t be long until the land above the Permian Basin — dubbed ‘Saudi America’ or ‘Texarabia’ — commands US$100,000 (AU$127,480) per acre.

Yet there’s a chance folks are getting a little too excited over what could be yesterday’s news. In fact, if my colleague Greg Canavan is right, the US shale industry may be more myth than fact .

That doesn’t stop market commentators dreaming about the Permian Basin’s possibilities, though. The Hughes Baker Rig Count in the US says that out of the 315 new oil rigs added in the last year, almost half of those are located in the Permian Basin.

Goldman Sachs even says that the Permian’s output could surge by 310,000 barrels per day (it currently pumps out 2.2 million barrels per day). If the Permian hits Goldman’s target, this 194,000-square-kilometre region of Texas would be responsible for roughly a quarter of total US oil production.

Unsurprisingly, US shale companies paint a rather optimistic picture of the area. Pioneer Natural Resources [NYSE:PXD] CEO Scott Sheffield says the Permian could exceed five million barrels a day, making it bigger than the Ghawar Field in Saudi Arabia — currently the world largest oil field.

That can’t be ruled out.

But US shale developments have a history of exploding with production growth before rapidly drying up.

As Greg showed to subscribers of his Crisis & Opportunity  advisory recently, output in the Permian continues to climb, even as the two other major US shale deposits in the US (Eagle Ford and Bakken) decline.

Oil Production Peak 2-10-17

Source: Crisis & Opportunity; Forbes
[Click to enlarge]

Chances are that won’t last forever.

Underpinning the booming land price value is the new oil estimate from IHS Markit Ltd. The research firm reckons there are about 60–70 billion barrels in the Permian Basin. Enough to supply every US refinery for the next 12 years.

But ‘probable’ and ‘proven’ resources are two different things.

Actual supply in the Permian is up for debate. The US Energy Information Administration put proven reserves at 722 million barrels of oil. Which is nothing compared to Saudi’s Arabia proven reserves of 286 billion barrels.

More to the point: How long will the excitement over the Permian last?

Arguably, with the price of West Texas Intermediate hovering around US$50 for the better part of this year, the profitability of the US shale industry is an issue.

Many Permian producers claim their ‘breakeven’ costs sit around US$30 (AU$38.24) a barrel. But Arthur Berman, a Texas-based petroleum geologist, says this doesn’t include interest payments, corporate costs or other components that affect profitability.

Furthermore, there’s a limit to how many horizontal wells can be drilled before they crowd each other out. And shale wells tend to dry up quicker than traditional methods.

This view is backed by energy resource scientist David Hughes in his 2016 ‘Tight oil reality check’ report. Hughes points out:

Longer horizontal laterals with higher volume treatments drain more area and reduce the ultimate number of wells that can be drilled without interference. Hence better technology produces the resource sooner — and at potentially greater profit — but does not imply greater ultimate recovery.

The consumption of the highest quality drilling locations during this period of low prices means that progressively higher prices will be needed, along with much higher drilling rates, to access the poorer quality portions of shale plays and maintain production. Typically, sweet spots comprise less than 20% of total play area.

Overly-optimistic oil companies are lapping up the low interest rates in the US, as it allows them to expand through increasing debt. Yet, seemingly, being positive cash flow doesn’t matter when you are ‘investing’ in the future.

Both Diamondback Energy Inc. [NASDAQ:FANG] and Pioneer Natural Resources fall into this bracket. Both companies have had free cash flow running in the negative for the past couple of years.

Instead of paying off debt, these two, among other shale companies, are spending any available capital on acquiring new land and equipment to keep pumping.

But what if all this drilling has led to these companies pumping only the sweet spots?

Greg explained in a report last month that the US shale industry has been targeting the easy oil for nearly a decade. He reckons this cheap oil will dry up, and that US shale companies will be facing much larger costs to keep the pumps on.

As he sees it, the US shale industry is nothing more than a mirage that will become apparent sometime in 2018. To learn why, click here to access Greg’s latest report.

Kind regards,

Shae Russell,
Editor, Markets & Money

Shae Russell started out in financial markets more than a decade ago. Working with a derivative brokering firm, she helped clients understand derivative markets, as well as teaching them the basics of technical analysis. Since joining Port Phillip Publishing eight years ago, Shae has worked across a number of publications. She holds the record for the highest-returning stock recommendation, in which a microcap stock returned over 1,200% in six months. Ask her about it, and she won’t stop yapping on. For the past two years, Shae has worked alongside Jim Rickards as his Australian analyst, translating global macro trends for Aussie investors, and how they can take advantage of these trends. Drawing on her extensive experience, Shae is the lead editor of Markets & Money. Each day, Shae looks at broad macro trends developing around the world, combining them with her distaste for central banks and irrational love of all things bullion.

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