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US shale extraction and the mirage that was

20th February 2015


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Unconventional reserves, unlike cheap conventional sources, remain vulnerable to market conditions, technology and geological characteristics. Transplanting from one country’s conditions to another will always remain a challenge, given the different conditions that prevail. The US situation illustrates this point more than anything else at the moment. The jury is still out on whether the US experience can be replicated elsewhere and whether extraction from shale plays has longevity.

Technological change and learning rates are one part of the equation, but the profitability of economic reserves, rather than technically recoverable reserves, requires a convergence of factors to sustain high rates of production of either shale oil or gas. The extraction of oil or gas from shale plays only works if you can sustain the treadmill of drilling that is needed to keep the production of the resource going for as long as you can.


These dynamics can be underplayed or be ill understood by enthusiasts of unconventional sources of oil or gas. The Organisation of the Petroleum Exporting Countries’ (Opec’s) decision to allow market forces to play themselves out rather than allow the effect of monopoly power to bolster the price margins for shale oil or gas illustrates what happens when price expectations are not sustained. Opec and, in particular, Saudi Arabia, a swing oil producer, pursued a market correction strategy to ensure their continued market dominance.

This strategy may not shut all the US shale oil operations but will hurt them and bring about a restructuring of the industry. Some industry experts are of the view that it had to happen at some point. The anarchy in the US shale market has always been viewed as unsustainable.


The consequence of Opec’s decision did not involve a long lag in transmission. Prices plummeted rapidly – by almost 50% – in two months. Nonetheless, US oil and gas prices were already lower than international benchmark prices because of a glut in supply as US crude exports are banned.

Most crude generated from shale is sweet crude, which is suitable for refineries along the East Coast, as refineries in Texas can only deal with heavy sour crude. Owing to bottlenecks in the transportation of sweet crude from the west and the north to the East Coast, there has been a supply glut, with underuse as a result of transport and refining capacity issues within the central collection point in Cushing.

This problem will remain even when prospects for shale oil improve, as long-term transport infrastructure can only be financed if long-term supply can be assured. There is no guarantee that shale plays can offer this because production rates are dependent on drilling intensity.

The current price free fall and expected drop in production will be a damper to any further investments in transport infrastructure to support the rebalancing of supply with demand, especially for sweet crude. Some of these infrastructure issues will also have implications on the future of shale oil production, especially from sources in North Dakota.

Now that the shale revolution is in danger of collapsing like a pack of cards, jobs are being cut across many US plays, especially the very marginal wells. In North Dakota, recently, 9 000 jobs were cut. Rig counts are going down and companies that are highly leveraged with debt will either have to liquidate, be bought out for much lower asset values or restructure. So far, $500-billion has been invested in US shale plays. Half of US oil production came from shale plays.

There is going to be a financial bloodbath. It is still too early to know exactly what its aftermath will look like. What we do know is that, if the bigger oil and gas companies are writing down their assets, as BHP Billiton has just done for its shale-plays – to the tune of close to $4-billion – the smaller players will soon be out of the game. Many of them have high debt leverage and have signed forward contracts that they still have to honour.

Some bubbles last long with the lift of cheap money and high oil prices. Managed production rates for oil by Opec countries have created an artificial pricing that has served as a subsidy to low-performing shale plays in the US. Shale oil extraction viability varies for different types of shale plays. Some of these breakeven prices cannot be stated with a great deal of accuracy because different firms treat these as a trade secret, especially drilling costs and recovery rates.

It is not difficult to recognise that while there has been a technological revolution in the US in tapping remnant oil and gas deep beneath the earth in shale formations, this cannot be done without cheap money and direct and indirect subsidies. Sceptical experts have always pointed out that shale oil and gas are, by nature, marginal and dependent on both drilling intensity and high oil prices to sustain reasonable rates of production. And do not forget the indirect subsidies for lax or lowly enforced environmental regulations.

They always say, when a thing looks too good to be true, you should look even closer at the numbers and the stats. Do not believe everything you see. In a way, the shale game changer in the US has been a sort of mirage that people thought would last forever. Nothing lasts forever. It is always necessary to be dispassionate and prudent than be caught up in euphoria. On our shores, there has been much euphoria and, many times, little knowledge has been a source of massive understandings. Too much excitement must be tempered with a good dose of realism.


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