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Conventional oil economics deal another blow to fracking

Despite continuing low oil prices having all but bankrupted the fracking industry, North Sea oil and gas production just hit a 15 year high.  According to Emily Gosden in the Telegraph:

“Oil and Gas UK said it expected last year’s 10.4pc increase in production – the first rise in 15 years – to be followed by another rise of about 6pc this year as the industry “lives off the fat” of huge investment in the years before the oil price crash.”

The timing of this increased production could hardly be worse for all involved.  With the current glut in global oil and gas, investors have been bailing out of the industry in droves.  New discoveries are at an all-time low, and oil companies are now pumping four times more oil than they are discovering.  Without increased investment, there is little chance of avoiding global shortages and recessionary price spikes within a few years.

The increased production poses a particular problem to a fracking industry that depends upon high prices (and large amounts of speculative finance) to break even.  This is largely because of the relative pace at which the conventional and unconventional arms of the energy industry operate.  Fracking is quick.  It takes just a few months to drill and frack a well and to begin recovering oil and gas.  Conventional oil is slow.  It takes years – sometimes decades – between identifying a new field and recovering oil and gas.  Similarly, fracked wells deplete fast.  Whereas a conventional well can produce oil and gas for decades, fracked wells can lose 90 percent of their production within three years.

This difference in pace has condensed an economic phenomenon known as the “choke chain” in which new investment leads to increased output, leading to lower prices and a withdrawal of investment.  In conventional oil, this process can take a decade or more to play out.  With fracking, it takes a matter of months!  In 2011, the US shale plays saw a massive influx of investment on the back of historically high oil prices.  The result, in short order, was a massive glut of oil and gas in a country that consumes a quarter of the world’s energy.  By mid-2014, prices had crashed and investors were heading for the hills.  Today, with prices settled just below $50 per barrel, what remains of the US fracking industry is desperately hoping that the world burns its way through the current surplus so that prices spike upward once more.

The North Sea production results may dispel some of that hope, since they suggest that the longer-term choke chain phenomenon in conventional oil has caught up.  As Gosden notes:

“The long lead-times in the industry mean the current pick-up in production – which is forecast to continue until at least 2018 – masks the dire lack of investment in further projects needed to sustain output in coming years.”

That is, investments in conventional oil recovery – also made back in 2011 when prices were high – are only now beginning to pay off.  Just at the point where the energy industry needs high prices to get fracking up and running once more, it looks like conventional oil companies are about to deliver another two or three years of low prices.  It could be 2019 before prices rise to a point where fracking is profitable.  By then, the fracking industry may have already gone bust.

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