There Will Be Math: Fracked Oil

I saw the following chart in an issue of Peak Oil Review, a publication about the oil industry.

 

Note the numbers on “U.S. light tight oil.” This is what we would call fracked oil, that is, oil from one of the shale deposits in the U.S. What distinguishes these deposits is the difficulty of extracting oil from them. They have low permeability; the gaps in the shale are small and not well connected, so there isn’t much oil per cubic meter and that oil has a tough time moving through the rock. Just for comparison, sandstone oil deposits in Saudi Arabia have a permeability of about 5 Darcies. (A Darcy being an oil industry specific unit of permeability and perhaps 19^th century English hunkiness) An American shale deposit might have a permeability of 5 milliDarcies, one-thousandth as much.

The answers to these problems are horizontal drilling (“bottle brush” wells) and hydrofracturing, the injection of high pressure fluid to crack open the shale. These are expensive processes.

Note that in the chart the capital costs are per peak daily barrel, not the average. Because of the nature of a fracked well, the output tends to be extremely high at first, but tapering off quickly. A fracked well might produce most of its total output in the first few years of production. In contrast, a conventional oil field in the Middle East might slowly develop to peak production and last decades. Note the relatively low capital and production costs for Iraq and Saudi Arabia.

Elsewhere, on an investment site called Seeking Alpha I found a graph of projected and actual production from a particular well drilled in the Bakken shale formation in eastern Montana and western North Dakota.

 

Looking at these numbers it strikes me that the pessimism I hear about the economic viability of these shale formations is well founded. I’ll apply the numbers from one to the other to get a general idea of the economics. Right now crude oil is around $57/barrel. Subtract the $8/barrel for production costs and the oil producer will have $49/bbl to work with.

The well in question peaks at about 475 barrels per day. By the EIA chart, a 475 bpd well costs between $28 million and $42.75 million to drill. The average over six years is about 1/3 of peak, so drilling costs $180,000 to $270,000 per average daily production.

At $49/bbl, $180k/$49 = 3673 days to breakeven, or about 10 years. The higher number, $270k, gives a breakeven point of 15 years. Add interest payments to that.

Right now those millions are coming in the form of junk bonds and venture capital. The bonds pay around 5-7% interest. The investors want higher returns, but I’ll be optimistic and assume 5%. At the low end that starts off with interest payments of $1.4 million/year, which is $3835/day or 78 barrels breakeven at $49/bbl.

Eyeballing at the production graph, the first 3 years average 150 bpd so the well makes $2.68 million/year, netting about $1.3 million/year. Problem: If the loan period is ten years, then annual interest and principal would total $3.64 million. This well could make that in the first year, but not the second.

Note that the producers re-fracked the well when it dropped below 100 bbl/day. Re-fracking costs about $2 million and brings it back to 100-200 bbl/day range for a couple of years. With an average over the next few years of a bit over 100 bbl/day, this adds a year to the breakeven point.

At the end of six years the flow has dropped to around 50 bbl/day. Even if the production company had somehow been making full payments all along, this is still something close to the breakeven point for just paying the interest (~$890k). There are at least five more years to go before the well makes back its initial investment.

This is all generalities, averages, and back-of-the-envelope, but even with a more optimistic scenario it doesn’t look good for the loan officer who approved this one. The operators will struggle to eke out sufficient total production and will probably hit permanently negative cash flow just two years in.

Not all sections of the various shale fields are the same. There is a concentrated area of low cost wells in a few western counties of North Dakota. These wells can make money at $40/barrel. On average, though, shale oil is a losing proposition in the mid-fifties. The average breakeven price is more like $60, and shale oil in the U.S. suffers from price discounts due to inadequate transportation infrastructure. Conoco Phillips, the largest U.S. oil exploration company, has announced that it will not pursue any opportunities with all-in production costs of over $50/barrel. That limits their options.

As recently as the summer of  2014 the WTI oil price was over $100. A combination of U.S. and OPEC overproduction killed the price. U.S. shale oil production went from 1 million barrels/day in 2007 to a peak of just over 5 million in 2015. It has dropped by a million since then, but OPEC is holding back production to keep the price in the $55-$60 range. They can crash the price again if they think wiping out U.S. shale production is in their interests. Then again, if they manage to crank the price over $60 fools will rush in and complete half done shale wells and the overproduction will drop the price again.

Witness the string of bankruptcies in the shale oil and gas sector. There were 89 last year alone. Investment has dropped off and the rate of new wells being drilled is down. Most of the major players are burning at least $500 million annually.

I know you will be shocked, shocked, by this, but it looks as if the shale oil boom was mostly a con from the beginning. It efficiently transferred cash from the pockets of investors, banks, and bondholders into the pockets of drillers and oil service companies. It was less efficient at transferring oil out of the ground for less than the market price.

The 10% Solution

So, recapping from my last post:

Russia interfered with our 2016 election in a big way and deserves some kind of spanking for that.

Russia’s economy and government are vulnerable to variations in the price of oil.

Given that we use so much of the world’s oil, small variations in our demand can make a big difference in the world oil market, and therefore oil prices. If our demand drops significantly the price of oil drops even more significantly, and Russia essentially goes bankrupt.

My first impractical suggestion was that we all slow down on the highway and cut our oil consumption that way. I have an equally improbable, yet technically feasible suggestion about how we could achieve the same goal. I should note up front that I don’t expect this idea to go anywhere while the present administration is in the White House and former Governor Goodhair of Texas runs the Department of Energy. For that matter, until we get the oil companies backed off from Congress a few paces. Here goes.

This proposal has two inextricably interlocked parts: An efficiency and conservation effort and a strike price tax on imported oil.

First, the strike price tax. It’s an odd tax, in that it isn’t a fixed percentage or a fixed fee per unit of taxed stuff. It is a fixed target price. The price of oil in the U.S. (the WTI or West Texas Intermediate) as I write is around $52 per barrel. The international price (Brent) is around $57 per barrel. A strike price tax would establish a target price of, let’s say, $60 per barrel. Right now that would mean a $3 per barrel tax on imported oil. If Brent goes to $56, a $4 tax, and so on. We presently import about 5 million barrels a day (mbpd), so every dollar in tax raises $1.8 billion per year. Such a tax would fix the U.S. domestic price of oil at $60 per barrel as long as we import any significant amount. The jump from $52 to $60 would add about 13 cents to a gallon of gasoline. Not wonderful, not catastrophic. The beauty of this tax is that we could set it at the price of oil at the time of introduction and American consumers would see no price difference at the pump.

Second, start a publicly announced effort to reduce our national oil consumption by 10%. Just 10% to start, but with intimations that if this worked out well we would keep going to 15% or even 20%. This would be financed by the strike price tax on imports. That initial $3 per barrel would get us $5.4 billion annually to start with.

The money would go to all the things you might imagine: sealing and insulating houses, office buildings, and factories (oil heated ones), upgrading heating systems, giving incentives for more efficient building methods, public transportation improvements, incentives for gas mileage improvements in vehicles, infrastructure assistance for states and cities, and so on. Whatever works. 10% wouldn’t really be a stretch, especially when one considers that an average European uses 40% less energy than an average American.

Even before we hit the 10% mark, world oil markets would react. We would be proposing the removal of about 2.5% of world oil demand when a less than 1% glut dropped the price of oil into the $25 - $30 range just over a year ago. I’m sure the Brent price would drop $5 just on the announcement. That’s another $9 billion a year for us to work with.

So what is the fallout from a program like this? Going back to the primary motivation, Russia would be in trouble.

In direct terms, oil and gas production is 16% of Russian GDP. According to a study by the Carnegie Moscow Center, when we calculate the indirect money flows generated by Russian oil and gas, it’s really more like 60-70% of GDP. It accounts for 50-60% of Russian government revenue and over 50% of exports. If the Brent price dropped by half, Russia would suffer an across the board revenue loss of 25%. It would be just punishment with essentially nothing that the Russians could do about it. Vladimir Putin would be busy struggling for political survival and Russian focus would have to turn inward.

The Persian Gulf monarchies would also suffer. Their cost of production is generally below $10 per barrel, so they would still make money. Their princes would have to buy gold *plated* objet d’art instead of solid gold and distribute more to the general population. They also might find it harder to come up with under-the-table protection money for all those jihadists.

Our European allies with diversified economies would enjoy some price relief, as would any non-oil based economies.

Here in the U.S., the price of oil would be high enough to maintain domestic production. Perversely, oil exporting countries would be tempted to increase production to make up for per-barrel losses, exacerbating their problem. The domestic price of oil would also be stable so that individuals, institutions, and businesses could invest in efficiency improvements with the expectation of a return on investment. Maintaining the price of oil would also prevent people from rushing out to buy giant urban assault vehicles.

It would be a massive job creation program. Energy efficiency is labor intensive. It requires individualized site analysis and design, and real people in person doing renovations. The insulation, sealants, large appliances, and construction materials tend to be domestically produced. Investing $10 billion a year into energy efficiency will create far more jobs than dumping the same money into refining and distributing foreign oil.

It would reduce U.S. health care costs. 10% less oil burned means 10% less emissions from oil products. We could see near instantaneous reductions is rates of asthma and long term reductions in lung and heart disease.

So much winning. So much Russian dismay. So much resistance from Exxon-Mobil. Any policy like this is on the other side of a political turnaround. Still, we need to do more than oppose the present stupidity; we need to propose new ideas.

Driving with Putin

Right now a lot of us are in reactive mode. Trump, Kim Jong Un, Harvey, and Assad keep throwing sand in our faces and we spend all our time trying to wipe it off and move forward. Even with all this political chaos we should pause, stop reacting for a minute, and make proposals. The persuasive power of “not that” diminishes with repetition.

U.S. intelligence services have established within a reasonable doubt that the Russians interfered in our last election. The details of the extent and Russia’s success are yet to be completely uncovered, but we know our political parties were hacked, our voting records were hacked, and our social media were clogged by a deliberate propaganda campaign. It is probable that the Trump family/campaign and the Republican Party were both involved in Russian money laundering.

This raises an important and tricky question: How do we retaliate against a nuclear armed nation that is also the world’s largest oil exporter? The answer is in the question. They are the world’s largest oil exporter. We are the world’s largest oil importer. The imbalance in this relationship seems to give them an advantage, but it is exactly the opposite. They can’t afford to export less oil. If we do it right, it is no problem for us to import less. The price of oil and the state of the Russian economy hang in the balance. A fine balance it is.

Right now the international oil cartel OPEC is trying to restrict the output of its member states in order to bring the price per barrel above $50. Last November, OPEC and its allies agreed to cut output by 1.2 million barrels per day (mbpd) as of January 2017. That compares to world production of 98 mbpd and OPEC production of 33 mbpd.

The U.S. consumes about 19.6 mbpd, and 43% of that, 8.5 mbpd, gets refined into gasoline for cars, SUVs, and light trucks.

An average car in the U.S. gets around 25 mpg. However, that mileage goes down as driving speed goes up. The U.S. Department of Energy, on its fuel efficiency page, notes, “Aggressive driving (speeding, rapid acceleration and braking) wastes gas. It can lower your gas mileage by roughly 15% to 30% at highway speeds and 10% to 40% in stop-and-go traffic.” Slowing down from 75 mph to 65 mph would raise mpg by about 10%.

And we do go 75 mph. A study by the Insurance Institute for highway safety showed that on rural interstates anywhere from 7% to 49% of drivers were going at least 75 mph.  In some places over 10% of drivers were going over 80 mph.

I’m going to make a wild ass estimate and say that if, as a nation, we just chilled out and slowed down, we could raise our overall gas mileage by 15%. Our fleet gas mileage would go from 25 mpg to 28.75 mpg. We’d use 13% less oil for gasoline production. That’s 1.1 mbpd. (See the hard won 1.2 mbpd reduction, above) That’s a nightmare for OPEC and a nightmare for Russia.

In February 2016, before the OPEC reduction agreement, the price per barrel touched $30. It could go there again without much more of a glut. That would cut Russian government revenues by 25%, their exports by 25%, and knock about 10% off their GDP. Ouchski.

Now, I’m not expecting Americans to suddenly become Prozac nation behind the wheel. I did this thought experiment to point out what a close run thing the world oil market is. Slight wobbles in supply or demand cause dramatic price swings. Even the prospect of such changes makes the commodity markets jump. It wouldn’t take a lot for us to use the power of our demand to rock the world. I mean, I’m not asking people to donate a kidney. Actually, I’ll bet some people would donate a kidney in exchange for the right to speed.

I have another idea, more pragmatic, although politically a stretch, that would do this and more. I’ll get to that one next time.

A Revolutionary Idea

It being Fourth of July, my thoughts turn to the Declaration of Independence. I reread it every year around this time. It is good to renew my acquaintance with it, and sometimes I extract something new. The following is not new to any scholar of the document, nor will it be a surprise to anyone with even a passing knowledge of it. Still, I think it deserves to be pointed out.

Here is the passage that has my attention:

“That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, — That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.”

This was hot stuff in its time. The 18th century was the tail end of an era that accepted the divine right of kings. Monarchy wasn’t right because of any utilitarian considerations, although there were apologists who argued for it. Monarchy was the opinion of God, manifest in the person of the king or queen. A monarch who fell was out of favor with the corner office, and the usurper who donned the crown had better connections in high places, as well as some pedigree. Thus it had been for all of human history. The “deriving their just powers from the consent of the governed” bit was wishful thinking in 1776.

In this section of the Declaration these students of the enlightenment were proposing that no particular form of government was inevitable. No particular set of laws or set of rulers was inevitable or inherently correct. It was a utilitarian, empirical, results-oriented view of government. This statement proposed that traditions and institutions, even long standing national governments, were not sacred.

It makes me think of Israel, actually. One of those demands that Israel and its allies make of political opponents is to acknowledge Israel’s right to exist. It is a ridiculous demand. People have a right to exist, as individuals and as groups. Israelis have a right to exist. Israel as a form of government has no more right to exist than France, Liberia, Uzbekistan, Japan, or the United States.

Governments earn the privilege of existence. Or they fail to earn it. It depends upon how well they serve the interests of people they govern. That is the remarkable, world changing proposition of our founding document. It is our responsibility to hold our government to account and make it earn that privilege.

I wish you a happy 4th of July. 

Heads Up – A Correction

"Making predictions is difficult – especially about the future." Danish Proverb

"Past performance does not guarantee future returns." Wall Street Boilerplate

"Enough drops make a bucket." Minor Heretic

Sometimes I get things wrong, and it is my duty to correct them. In my last post I referred to the work of a few citizen journalists and their predictions of imminent law enforcement actions against members and associates of the Trump administration. I got caught up in some social media hype and allowed myself to be conned. The sources in question had a few scoops that beat the mainstream news outlets by a few weeks, but then they went off the rails. Sorry about that.

It looks like it is going to be a long slog towards impeachment. Given that the majority of Republicans in Congress have unequivocally chosen party over country, nothing is likely to happen with a GOP majority. I believe that Trump could stab a little girl in a pink dress on Pennsylvania Avenue and the GOP would complain that the media sensationalized the incident.

The only shortcut to Trump’s departure that I can see at this point is the prosecution of people around him to the point that he feels isolated enough to resign. What with all the money laundering and perjury in his vicinity this is a possibility. I do think that having Robert Mueller as Special Counsel almost guarantees that the dirt will be dug up and a number of present and former key players in the Trump Administration eventually will be prosecuted. Flynn, Manafort, Page, and Sessions are at the top of my list. Probably Mueller’s as well. No guarantee as to the schedule, though.

In the meantime, we should focus on flipping the House and Senate to Democratic control. There are a number of organizations nationwide dedicated to this. In particular, there are several organizations focusing on so-called purple districts, where either a Republican or a Democrat won the last election by a narrow margin. You should look at the following organizations and join one.

Indivisible Guide at https://www.indivisibleguide.com/ This was started by a group of Democratic congressional staffers who were, post election, discussing the methods of influencing members of congress that actually worked. They wrote the Indivisible Guide as a brief instruction manual for progressive activists. It became a national movement with local chapters. Whether or not you join the organization I strongly recommend that you read the guide on their website.

Sister District at https://www.sisterdistrict.com/ This is a group for people who live in states and/or congressional districts that are already Democratic, but still want to work on flipping congress. A blue district adopts a purple district and assists groups and candidates.

Swing Left at https://swingleft.org/ is another organization, much like Sister District, that matches people with nearby swing districts. They define a swing district as one that was won by less than 15% in the last election.

Flippable at https://www.flippable.org/ focuses more on state legislative races. The Republican Party has spent a lot of effort in the past decade on state races. As a result there are 25 “trifecta” states, where both houses and the governor are Republican. This allows them to lock their states with gerrymandering and voter suppression. Flippable is working on bringing these states back and reversing the electoral crimes of the GOP.

Many of my readers may not be completely pleased with the Democratic Party, and neither am I. A party that claims to be for the common people and also has $10,000 a plate fundraising dinners is lying. It is lying to itself and it is lying to voters. The Republicans are worse in this regard, but the Democrats need reform. However, these grassroots movements are part of that reform. They rely on small donations and a lot of volunteer labor. The more that the Democratic Party finds this useful, the less it has to rely on large donors.

Pick a group, any group, and try something. I’m signed up with Sister District and a local Vermont group associated with Indivisible called Lean Left.

Again, sorry for passing on the hyped fantasy. We all would like to believe in a quick duex ex machina ending to all this, but life is not a superhero movie. No one person will save the world; we all have to save our tiny piece of it.