From The Wall Street Journal
How low can oil prices go? When pundits start competing to predict where the barrel will hit bottom, you know that a rebound is inevitable. It’s the inverse of what happens before a high-price bubble bursts. Only a few years ago forecasters were suggesting that oil might hit $300 a barrel.
The unpleasant reality is that petroleum prices are cyclical. Starting with the 1973-74 Arab oil embargo, they have been through six extremes. Because the peaks and the valleys both wreak financial havoc, producers and politicians imagine a Goldilocks ideal, with prices “just right”—not so high that legislators feel pressure to claw back “windfall profits,” and not so low that suppliers fall like dominoes, destroying jobs and tax revenue.
The latter is what we’re seeing now, with oil falling below $30 a barrel. Survey the damage so far: More than 100,000 jobs are gone, most of them last year. The number of shale rigs in service has collapsed by 60%. Banks are worried about their oil loans. Shale states are readjusting budgets for shortfalls. About $200 billion of oil and gas assets are up for sale world-wide.
American shale oil companies—whose booming production is a principal cause of the global glut—have been hit hard. Last year two dozen defaulted and 15 filed for bankruptcy. Standard & Poor’s puts junk ratings on three-fourths of the oil and gas producers it monitors.
Here’s the big question, the one that makes this cycle different: What happens to shale oil? The jobs and revenues from America’s newest industry literally kept the country out of recession during the years of tepid growth that have characterized the current administration.
The bad news is that there will be more pain to come. Low prices will continue to drive out companies that are overleveraged or poor performers. Stronger firms might suffer collateral damage. In the end, though, most companies will survive. Many will emerge well positioned for the next cycle, having acquired new assets (at distressed costs) that can be deployed as demand rises.
Even with China’s economy slowing, global oil use will still rise by 1.3 million barrels a day this year—equal to the peak daily output of the entire Bakken Shale field. Middle-class automobile ownership in Asia is rising steadily, from today’s average of 60 to 80 cars per 1,000 residents toward the West’s 600 to 800 cars. All the fundamentals point to growing demand for oil.
When prices rise again, even modestly, as they eventually will, shale producers will be ready—and this is what worries OPEC, Russia and Iran. Many foreign producers need oil above $80 a barrel to balance their national budgets. Yet industry experts at RBN Energy foresee vast swaths of American shale profitable at just north of $40 a barrel. And it can come online extremely quickly.
The billion-dollar projects of conventional oil require long planning by enormous corporations or nation-state monopolists. Each shale well is comparatively tiny—which is why tens of thousands are drilled. Permits are obtained in weeks on private and state lands (where so much shale resides), and the wells are drilled in months instead of years. Structurally speaking, shale resembles a multitude of small tech-factories “manufacturing” oil from rocks.
When prices tick up, thousands of profit-seeking investors make individual decisions to turn each factory’s switch to “on.” That’s how the U.S. so rapidly achieved, from 2009 to 2015, the record-breaking rise in production of four million barrels a day. Remember, global prices are affected by changes of only one to two million barrels a day. The upshot is that absent something like a major war, oil prices won’t be able to spike again. That’s especially true now that America can finally sell oil in world markets, courtesy of Congress’s recent lifting of the export ban.
Shale 2.0, when it comes, will be even better. The technology is advancing at a speed usually associated with Silicon Valley. Over the past half-decade, average output per rig has risen at least 400%. Productivity rose 40% last year, despite cost constraints. The rigs are getting cheaper, and the efficiencies brought by the latest tools—from data analytics to robotics to advanced materials—have yet to be deployed.
The shale industry expanded during a period of cheap money from the Federal Reserve. Over the past decade, a collective $1 trillion was exuberantly invested in a vast infrastructure of pipes, tanks, refineries and factories, as well as intellectual property and skills. In a sense, the boom looks a lot like the 1990s investments in dot-com firms.
Just as a new Internet ecosystem rose from the ashes of the dot-com crash, Shale 2.0 will emerge—and for the same structural reasons. Underlying physical and intellectual assets don’t evaporate in bankruptcies, and America’s investors and entrepreneurs are resilient. There is plenty of capital standing by; more than a half-trillion dollars sits in the coffers of oil companies and petroleum private-equity firms. The bellwether for Shale 2.0 will be a boom in mergers and distressed asset acquisitions.
In 2016, however, low oil prices will likely persist, and there’s an argument for letting creative destruction take its course. Competition is about to get fiercer as Iran, now sanction-free, adds to markets as much as a million barrels a day. Why not create incentives to propel America’s Shale 2.0 technology, the key to competing at low costs? Congress could fund shale science and technology programs, without tapping taxpayers, by selling, over time, some of the $10 billion-plus in excess oil stored in the Strategic Petroleum Reserve. Less oil is needed in the reserve anyway, thanks to the shale industry.
Lawmakers should create a public-private program on Strategic Petroleum Research Technology to get next-generation shale tech out of the lab and into the field. Today hydrocarbons account for only 8% of federal energy research, though they supply 80% of America’s energy. It’s time to send a signal to markets, our allies and not-always-friendly competitors. America’s tech-centric shale “factories” are here to stay—and getting better all the time.