Steven Kopits is the Managing Director of Princeton Energy Advisors, LLC. He is currently writing a book on supply-constrained oil markets analysis.

Once again, we return to the debate over the direction of oil prices, this time led by the high price school.

In a recent article, Professor James Hamilton of the University of California argues that sluggish supply growth, coupled with sustained emerging market demand, will tend to keep oil prices elevated. He writes, “the world of energy may have changed forever…hundred dollar oil is here to stay.”

This prompted a rebuttal from John Kemp, Senior Market Analyst for Commodities and Energy at Reuters. In Forecasts for Higher Oil Prices Misjudge the Shale Boom, Kemp highlights perceived weaknesses in Hamilton’s argument, stating:

“The problem with Hamilton’s analysis is that it largely ignores the impact of the shale revolution on the economics of oil production and understates the tremendous variability in real oil prices in response to changes in technology. So while Hamilton concludes that $100 oil is here to stay, in real terms, the outlook is far less certain. In fact, a betting man, looking at the price history, might conclude prices are currently abnormally high and due for a fall.”

Kemp seems to be arguing that shale oil is a game-changer which will materially change the supply outlook and catalyze a fall in oil prices.

To test this assertion, it is worth asking if shale production has actually led to the predicted fall in oil prices. As is well known, the shale surge caused a divergence of the West Texas Intermediate (WTI) oil price, the US domestic standard, from Brent, the international standard. Historically, these two prices rarely diverged by more than a dollar or two. Notwithstanding, from late 2011, surging shale production depressed the WTI price as US supply outran domestic infrastructure capabilities, and government regulations prevented the export of US crude.

Have prices fallen since? Growth of field production in the lower 48 states has been impressive, increasing by 400,000 b/d in the 12 months ending in mid-2011, and rising to a gain of 1 million b/d by mid-2012, a pace it has held ever since.

How did prices react? In the three months ending July 2011, WTI averaged $98, falling to $88/b a year later. On the other hand, by July 2013, WTI was back to $98, and will close this July around $104. Has surging shale production caused the US oil price to collapse? Not all at. It has been accompanied by increasing oil prices, even in the US.

Nor has Brent collapsed. True, Brent averaged $115/b in the three months to July 2011, and fell to $103 just a year later. But it will close this July at about $111/b, not much different from three years ago, and higher than it was at the beginning of the “shale gale.” Shale oil has not led, as a statistical matter, to lower oil prices in the US—or globally—in the last two years.

How can this be, if the oil supply is in such fine fettle? Has peak oil really been debunked? Is Kemp right when he says: “Since 2008, the dramatic increase in oil and gas production from shale formations in North America, and the abundance of shale resources around the world, has discredited theories about peaking oil production.”

As the chart shows, just as many analysts have contended, the oil supply hit an inflection point in 2005. That year signals the high water mark of conventional crude and condensate production, which is 2.1 mbpd less than it was then.

Even if we include refinery processing gain, biofuels and NGLs (these latter two adjusted for energy content equaling about 70% of that of a barrel of crude), we find the oil supply is up only 0.4%, 300,000 b/d, compared to 2005.

Virtually all of the growth—92%, on an energy-adjusted basis—has come from unconventionals, specifically, Canadian oil sands and US shale (tight) oil. Indeed, 70% of the net growth of the global oil supply from 2005 through 2013 came from US shales alone. Shales are not the icing on the cake; they are the cake itself.

This matters, because shale production in turn depends overwhelmingly on only two plays, the Eagle Ford and the Bakken, where production is expected to peak in 2016 or 2017 or see much slower growth in production as the sweet spots there are exhausted. The Permian Basin may pick up the slack, but to date has not done so in needle-moving quantities.

Meanwhile, lagging oil prices are calling into question a number of oil sands projects, particularly those slated to begin production after 2020. Unconventional growth may well be approaching its high water mark. If 1 million b/d growth has led to higher oil prices, what will happen when unconventional growth slows to 300,000 b/d in two or three years?

And there’s more. Kemp states: “North American shale is currently the marginal source of supply in the world oil market, and most producers claim they can break even at $70 or even $60 per barrel.”

It is not clear that the US independents are profitable. An industry can see a boom irrespective of profits or free cash flow if banks and investors are willing to underwrite the promises of future profits. The internet bubble showed us that.

We do not yet know if shale oil and gas will be consistently profitable. We do know, however, that US independents have been massively free cash flow negative in recent years.

This does not mean the shale oil, or even shale gas, is unprofitable, even if Shell was unable to make Eagle Ford economics work. It does mean, however, that the industry as a whole is not generating enough cash to cover its capex and the meager dividends these companies pay as a group. It will take a while until truly underlying profitability becomes apparent.

Nor are the US independents the marginal producers. This distinction falls to the international oil companies (IOCs), and the marginal projects are in deepwater, the Arctic and the Canadian oil sands. Goldman Sachs has calculated the free cash flow breakeven for several of the majors above $100/b, and as high as $130/b.

Even at recent oil prices approaching $110 basis Brent, the majors find themselves compelled to reduce capex. Reduced oil production may well follow reduced capex, just as it has at Hess, the most advanced of the oil companies in rationalization and capital discipline.

Now imagine that oil prices collapsed, as Kemp proposes. Oil production has been falling at the majors at a 750,000-1 million b/d as it is. A price collapse would accelerate this process dramatically, just as shale oil production is peaking. How would such an eventuality promote lower oil prices?

Kemp closes with this admonition: “But productivity has also increased as companies have learned to target the highest yielding formations and drill faster and more accurately. Hamilton’s paper is silent on all these matters, and that is ultimately what makes it unconvincing.”

Hamilton is most emphatically not silent on this matter. He writes, “Figure 12 [reproduced below] shows that combined production from the 11 largest publicly-traded oil companies has fallen by 2.5 mb/d since 2005, despite a tripling of their capital expenditures.”

As the graph above shows, productivity of capital has deteriorated by a factor of four, from $5,300 capex b/d of oil production in 2004 to $21,400 in 2013. This deterioration is net of technology improvements. Geology is not only winning, it is crushing technology.

Hamilton’s graph testifies to the grizzly unraveling of the economics underpinning oil production since 2005. For the oil business as a whole, productivity has imploded, not improved.

Jim Hamilton closes with a necessary caveat, noting, “certainly a change in…fundamentals could shift the equation dramatically. If China were to face a financial crisis, or if peace and stability were suddenly to break out in the Middle East and North Africa, a sharp drop in oil prices would be expected.”

These are, in fact, the downside risks. China is undoubtedly the medium to long term driver of oil prices. If China implodes, it will drag other emerging markets down as well. On the other hand, I may disagree about the likelihood that Middle East peace would lower oil prices durably. But this much is not in question: We are heavily dependent on shales to provide incremental oil, not only in the US, but globally.

As we look to 2017, the prospects for oil supply growth look increasingly tentative. US shales may be running their course, even as other countries’ potential remains untested. Oil prices will not rise to fully offset swelling E&P costs, and the oil majors will trim their sails to right their financial ships. Their oil production will continue to fall, and with reduced capex, the pace of decline could well accelerate, even in the face of stable oil prices.

In addition, international affairs are in a parlous state. In less than a year, Iraq has transformed from embodying OPEC’s upside potential to being the greatest risk to current production levels. Russia seems intent on provoking sanctions or embroiling itself in a European war. Neither augurs well for its oil exports or expansion of its oil business.

The supply upside is ever harder to perceive, even as the downside risks are multiplying. Instead of complacency, we should feel concern. An oil shock is already visible on the horizon ahead of us.

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