The fight for oil supremacy

Permian versus Saudi Arabia is the new oil vs. old oil

The Permian Basin in West Texas is almost where oil started. It’s definitely a highly symbolic region and means a lot to oil people. George W. Bush grew up there and epic oil movies like “There will be Blood” or “Giants” tell the story of this region.

They found oil in the 1920s. Since then the Permian produced up to 1 Million Barrels per day. By 2007 production shrank to 700,000 B/d. But then they invented something new. The fracking. They drill horizontally and frack the stone. Oil started flowing again and the Permian did around 2.2 Mio B/d in 2015.

According to oil people the Permian is the best source rock there is. And it’s in one of the best oil jurisdictions in the world. No hostile governments, no crazy terrorists, lots of local talent and proximity to markets is almost unheard of in oil. The Permian could become a huge resource.

But with oil in the mid 30s the Permian producers have to think twice. Investments are still made. The largest independent driller Pioneer Natural Resources just raised 2 Bio. $ to drill more oil in the Permian shale. But the math becomes more and more difficult.

Costs are around 8$ per Barrel to complete a rig. Operation cost are 7$. The rest is overhead and taxes. You need 25$-30$ to break even. That’s why at current levels people are cautious.

Saudi Arabia has cost around 5$ and doesn’t need to invest a whole lot to get it. Norway is probably around 12–15$ and other countries like Russia or Brazil are in the middle. Nevertheless, the Permian has an important role to play. Why?

First, there is growth. The Permian could become a huge resource. So if they can bring down cost even further, the Permian could become a price setter on the global market.

Second, the low production cost elsewhere only apply to current fields. New fields must be invested in and will cost more. In other words, the world will run out of oil at current prices and investment levels. New investments have to be made and they require higher prices. Prices in the range of 50$ should suffice to make oil interesting and to sustain a demand 93 Mio. Barrels/Day.

This ads drama to the current show down between Saudi Arabia and the Permian.

Something has to give. Either demand collapses or prices have to go higher so people invest more. Saudi Arabia cannot print oil at such low prices for a long time. The country has expenses, budgets, political rent seekers and lots more to pay for.

It’s a bit like the car race in “Rebel without a cause” when two guys sit in a car and race to a cliff and the first who jumps out looses.

Now, here is the interesting question. Maybe the large offshore projects will never materialize since prices might not rise high enough. So the drillers in the Permian could become the marginal producers. Maybe new oil developments will never again be conventional i.e. large upfront investments but more the factory style shale investments where you can scale as you wish and capital expenditures are controlled. This would be an interesting development.

In Natural Gas the US Shale players have already set a price which sooner or later will become a world standard. The only way to increase production is to produce like them. Large Natgas projects with huge billion Dollar investments are not feasible or very difficult to justify. The same could happen to oil.

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