Saturday, March 21, 2015

A picture worth ... $40 oil

Recently several commentators, including Rex Tillerson, the Chairman of Exxon, have analogized what is likely to happen to the US shale oil market to what has happened over the past few years to the US shale gas market.

According to the Wall St. Journal's summary of Exxon's most recent analyst presentation, Tillerson said that, "while he didn’t see a perfect parallel between shale gas and shale oil ... there were 'lessons' to be learned. The drop in oil prices has prompted 39% of U.S. oil rigs to be idled since October, stoking expectations of a rebound in the market. Yet Mr. Tillerson pointed out that the collapse in natural-gas prices similarly had led the number of rigs drilling for that fuel to drop to 280 from north of 1,600 in 2008. [But,] gas output jumped 50% in that time, he said."

The point that shale production may be somewhat impervious to price drops has even broader implications for oil than for gas.  If as many have suggested US shale oil indeed has become the marginal source of global oil supply, the potential impact of the effect on oil prices is global.  Because under current conditions natural gas operates in much more localized markets, to date the impact of the effect on the gas side has largely been limited to the US.

It has taken me a bit to get around to finding a way to present Mr. Tillerson's point in graphic form, but while on the Energy Information Administration site today running down some other data I found a quick way also to express Tillerson (and other's)  point.  The graph below charts US natural gas prices against production over time.  The US shale gas revolution largely is measured from 2007.  As can be seen from the chart, despite a roughly 70% price drop over that time period production has continued to rise by what is now approaching 35%.

If US shale oil is indeed the new marginal source of global supply and exhibits even remotely some of the same characteristics, then its going to be a long, hard road for oil prices to climb back even into the $70 - 80 price range.