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Analyst: Shale oil won’t threaten deepwater, but rising costs, oil prices might

In mid-2012, year-on-year oil consumption growth rates increased in the US while it slowed down in China. China’s slowdown has eased prices to an extent, allowing the US and Europe to increase oil consumption, according to Douglas-Westwood.
In mid-2012, year-on-year oil consumption growth rates increased in the US while it slowed in China. That slowdown has eased prices to an extent, allowing the US and Europe to increase oil consumption, according to Douglas-Westwood.

By Katie Mazerov, contributing editor

The boom in US oil shale production is not a threat to deepwater, an energy industry expert said, but rising costs and relatively flat oil prices will continue to challenge offshore operators looking to develop deepwater fields. “While a number of investment banks and government agencies have forecast that prodigious shale production will swamp demand for oil, we contend that the world remains short of oil. This shortage, rather than changes in habits or demographics, is driving decreasing oil consumption in advanced countries,” said Steven Kopits, managing director at Douglas-Westwood, which provides market research and consulting for the energy industry.

In December 2013, US oil demand reached 19.1 million bbl/day, an increase of 5.6% from the same period in 2012, Mr Kopits noted. Demand is Europe also picked up 0.2% after having fallen year-on-year since April 2011. Meanwhile, growth in oil demand has paused in China. “High oil prices have been aggressively suppressing demand. If prices drop, demand comes roaring back to life. Consequently, as the oil supply increases, any overhang is quickly absorbed,” he said.

“The fact that demand in China has gone slack for now has eased prices to an extent, allowing the US and Europe to increase oil consumption for the first time since 2005, excluding any immediate recovery from the trough of the recession,” he continued. “Contrary to industry expectations of just a few months ago, US demand is up considerably. However, if China returns to recent growth levels, as much as a 7% increase per year, markets could tighten very quickly, and pressure on advanced countries will resume.”

In such a supply-constrained world, oil prices will tend to rebound to the “carrying capacity” level, the price where consumers refuse to pay more, Mr Kopits explained. US oil production, driven primarily by growth from shales, “posted a blowout year, with December 2013 production 1.1 million bbl/day higher than a year earlier. Canada added an additional 0.45 million bbl/day. Yet the price effect has been minimal, maybe $3/bbl on a Brent basis. It has all been absorbed. In December, the US Energy Information Administration reported that demand was running 1.3 million bbl/day ahead of supply, even with the unconventional growth.”

Mr Kopits believes the chronically oil-short global economy will tend to see oil prices in recent ranges, without material, lasting downward pressure from increased production. “That is exactly what we’ve seen in the last two years and suggests that shales will be no threat to deepwater on the downside for oil prices,” he said. “It also suggests oil prices won’t rise much once they reach the carrying-capacity level.”

This poses a challenge for deepwater operators, as rising E&P costs have not been matched by corresponding increases in the oil price. “Upstream spend costs have been rising 11% annually on a per-barrel basis, even as Brent prices have eased slightly,” he said. Reasons for cost escalation include geology and location – for example, high-pressure wells in complex formations. Post-Macondo and Katrina, regulations also have played a role, along with increasingly conservative operator practices with respect to project management, HSE practices and quality control. The supply chain also has been burdened with costs, particularly for skilled labor.

“Cost drivers have raised the free cash flow break-even for the major operators to $120-$130/bbl,” Mr Kopits said. “Until there is a fundamental change in the model, operators will continue to be squeezed financially.”

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