April 10th, 2019

Why A Third Oil Price Peak Is Very Unlikely

By Rami A. Kamal

A key tenet in the 2016 Saudi Vision 2030 is to reduce the Kingdom’s dependence on oil. For the past seven decades the Kingdom relied on crude oil for around 90 percent of its gross annual revenues. Oil revenues found their way into every sector as the nation rapidly transformed from underdeveloped poverty in 1932 to the vibrant modern G20 nation of today. Along its quest for transformation, the Kingdom benefitted from two oil price peaks, or oil booms (1973-1985 & 1999-2014). This article demonstrates one factor on why a third oil price peak is very unlikely, hence a need to move away from oil dependence.

Historical Oil Price Trends and their Impact on KSA
By the late 1850s, crude oil was well on the way to becoming a world commodity of immense significance; a commodity that basically fueled the industrial revolution to unprecedented heights.

In 1861 the price of a barrel of crude was $0.46. By 1864 the price had steadily climbed to $8.06 before beginning a slide that brought it down to $1.19 in 1878. From 1878 the price remained below $2 per barrel for the next 94 years, except for a brief period after WW1 when the price of a barrel rose to $3.07, and in 1958-59 when it rose to $2.08, in response to civil strife in Lebanon to which Saudi Arab and Iraqi oil was piped for export. Thus, oil prices were subjected to geopolitical strains decades before.

In 1971 the average price of a barrel rose to $2.24. In 1972 the average price of a barrel of crude oil inched up to $2.48 further distancing itself from the artificial $2 ceiling. In the aftermath of the Arab-Israeli October 1973 war and the ensuing Arab oil embargo, the price of oil leapt to $3.29 per barrel and continued to rise. By 1980 a barrel of oil was selling at $36.83 per barrel.

The meteoric rise of the price of crude oil beginning in the Fall of 1973 catapulted a developing desert kingdom headlong into the modern world quickly as the government launched one massive modernization project after another. These projects included road networks, healthcare facilities, industrial zones, airports, seaports, colleges, telecommunications networks, city plans, endemic disease eradication, increasing literacy and life expectancy, erecting governmental complexes, dams, desalinization plants, power plants, vast power distribution networks; notwithstanding the creation of massive petroleum upstream and downstream facilities. In short, KSA became the leading Arab nation in industrial and financial clout.

The slide in the price of crude oil off the first peak began in 1985 when the price stood at $27.56.  By 1986 the price had collapsed to $14.43. The oil boom lasted 12 years but was followed by a 13-year economic slowdown during which the average cost of a barrel of crude oil bobbled between $12 and $25 depending primarily on the state of oil stocks and secondarily world events. KSA public expenditure continued during this inter-boom period albeit on a more cautious note, with a notable shrinkage in capital expenditure.

In 1999, the price of crude oil began a steady rise, signaling the start of the second, and, as will be demonstrated below, the last, oil boom. By July 2008 the price of a barrel of crude shot up to $145.58. The second boom’s downturn slide began in 2014 and lasted for 14 years triggering a massive pour-down economics bathing the desert kingdom in further revenue.

Why the Second Crude Oil Boom may have been the Last?
The price of crude oil is now locked in a Catch-22 situation. Whenever the price of oil rises over the $50 to $60 per barrel threshold, the shale oil companies launch into action forcing the price of oil down again. This will create a closed cycle that may stay in effect until the global retreat from crude oil takes grip, which is likely by 2050, at the very latest.
 
By early 2015, breakeven levels for drilling new wells in U.S. shale oil fields ranged from $50-$80 per barrel. Production operating costs in the shale oil industry are also high. In fact, many shale oil businesses with their higher production costs compared to the cost of extracting and producing subsurface crude oil pools in the Middle East, go into a state of suspension to wait out significant slumps in the price of oil.  This strategy illustrates that the U.S. shale industry does indeed have its faults and needs time to develop and mature.
 
Researchers and entrepreneurs see that U.S. shale has high operating costs which is impacting the way the industry sees itself in the future. Shale oil production costs per barrel have been steadily plummeting because of fluctuations in the market that may not have been expected. Waiting to drive shale oil out of the oil market by keeping down the price of subsurface crude does not appear to allow for the fact that shale oil production costs were also capable of dropping. This phenomena caught some observers by surprise.
 
In periods of drops in oil prices, oil shale operators have created the Drilled but Uncompleted or DUC wells, which are planned wells that are sealed and await reopening when the market permits. There are more than 8,500 DUCs across North America. The idea is that if the price of oil picks up, the operators can return to the waiting wells, frack them, and start up production in short periods of time at perhaps not more than 65 percent of the cost of drilling a new well.
 
As aforementioned, the cost of production of shale oil continues to drop because of another factor that is more obvious which is advances in recovery and production technology. Operators, entrepreneurs and researchers are constantly developing efficient and cost-effective solutions to shale oil production. These discoveries include continual discovery and improving drill time; enhancing yield per well; better rigs; better drilling techniques; better cementation, perforating, and recovery techniques; better fracking technologies and sanding applications; and improved big-data analytics. Most importantly, the number of global rigs that are operating are a useful metric to measure extraction capacity.  The further drop in production costs has been augmented by the moth-balling of hundreds of drilling rigs as the slump in the price of oil drove oil producers out of the market or into dormancy. Across North America the daily cost of a drilling rig has dropped to $18,000 and even less. This fact has allowed DUC producers and resilient oil entrepreneurs to drill at yet lower and lower costs.
 
The U.S. shale oil revolution has turned the global oil industry on its head. With hundreds of thousands of shale oil wells and billions of feet drilled, and with the realization of production breakeven dollar levels on par of those of Saudi Arabia, the oil shale revolution is not reversible. It may be said that shale oil has replaced KSA as the global crude oil swing producer.
 
Overall, as U.S. technology spreads beyond North America, and the cost of recovery of a barrel of shale crude drops, the recoverable global crude oil reserves will ultimately rise. Total world resources of shale oil are estimated at 4.8 trillion barrels, almost four times more than crude oil resources. In other words, shale oil is not going away soon as new fields are discovered and technology advances helps to bring this product to market.
 
Rami Kamal is a geologist and veteran of Saudi Aramco, with over 40 years of experience in the oil industry.