Can Moore’s Law apply to the oil industry?
Forget today’s price dive and yesterday’s notions about swing production. Capacity and agility are growing every year.
One of the most effective moves in sport is the head-fake. Boxing, basketball, football — you name it— a twitch of the head can be enough to send defenders in the wrong direction. It’s a thing of beauty when done well. But in commodities trading, falling for it can be disastrous.
Here’s what I mean. Right now, the media is focused on low crude oil prices, and the layoffs and rig shutdowns that follow. I say it’s a head-fake, because lots of companies are buying into the line and scurrying for cover, while the smart money slips past them on to victory.
The truth is you don’t have to fall for it. If you read between the lines, you can seize your share of opportunities now, while prices are down, and march into the next cycle well ahead of your competition. Let me explain.
Listen only to half of what you hear.
Obviously oil prices are down. Speculators continue to wonder whether they've finally hit rock bottom.
Some analysts think not. Jim Cramer of TheStreet suggested that, until earnings estimates are reduced, oil prices still have further to fall.[1] However, according to OPEC Secretary-General Abdulla al-Badri, we’ve already hit bottom and should expect a return to triple-digit oil prices “very soon.”[2]
Either way, a downward trend in many areas of the market prevails.
In the past, a downward move of 50% would have spelled disaster for the oil and gas industry. But new factors suggest a different view of what’s happening.
In its 89th Annual Forecast and Review, World Oil predicted the number of wells in the U.S. to drop 19.8% compared to last year, with Gulf of Mexico exploration and production activity, “particularly in deepwaters,” to continue at a lower pace.
The same report forecasts Canadian drilling to fall 30% over the same period, with global drilling outside of the U.S. to drop 6.8% and global offshore drilling to drop 8.8 %.
Halliburton, Baker Hughes, Schlumberger, Suncor, Pemex, Chaparral, ConocoPhillips and Royal Dutch Shell are just a few oil and gas companies on a long list who’ve made headlines lately for announcing massive layoffs.
In the past, a downward move of 50% would have spelled disaster for the oil and gas industry. But other factors not so widely reported suggest a different view of what’s happening.
The news gets better the closer you look.
Despite lower prices and dire news, the fundamentals generally point to a flurry of need. If oil prices can merely get back to the $60-$70 a barrel range in the next 12 months, and stay there for a reasonable period, U.S. production is poised to respond.
Many wells have shut down. Headcount has been reduced. But the infrastructure is there to pick up the pace at a moment’s notice. In fact, the recent volatility has created a much leaner breed of competitor. And from a logistics standpoint, a multitude of options have emerged — including rail, barge and tankers, to name a few — mostly over the past five years.
Here’s a hypothesis: oil field, drilling and information technology have combined to create a perfect blend of capability and agility that will allow American oil markets to respond with a speed typically only seen in computing.
Consider this.
Production is not dropping.
The U.S. Energy Information Administration (EIA) recently reported that oil production in the lower 48 states is stable, despite expected near-term reductions in in rig count. The report says, “Other key factors include the efficiency of drilling…the rate of decline in production from existing wells, and changes in the amount of time between the start of drilling and the completion of the well.”
As little as five years ago, it could take as long as nine months to get oil out of the ground. Today, thanks to rapid advances in drilling and information technology, it now takes no longer than 30 days to see results. You can literally go on holiday at the start of the process and come back to a producing well, just like that.
What’s more, because production has not dropped, the need for transport to market has not dropped. Oil tankers, pipelines, rail systems and the tracking technology behind these modes have all gotten more sophisticated in the past five years. As a result, there may be no better time to be in the global oil-transportation business.
Rig counts don’t matter anymore
As in many businesses, the 80–20 rule applies. In the oil business, 16% of the wells in operation across North America account for 82% of the oil produced.[1] And, generally speaking, production has been up.
It is the abundance of supply that is placing downward pressure on prices, with supply growth outside of OPEC nations growing at the fastest rate. According to the International Energy Agency, non-OPEC countries produced 1.9 million more barrels per day in 2014 than they did a year ago, with the U.S. leading the way at 1.1 million barrels.
As producers become more efficient, the number of rigs required to yield the same amount of production naturally drops. So, while the industry freely announces sensational rig count reductions, little to no impact on actual production is seen. That’s because the industry is taking this opportunity to shutdown low performing rigs.
In the case of the Eagle Ford region, one of the most prolific in North America, rigs are producing at a rate 18 times more efficiently than they were in 2008, and 65 percent more efficiently than they were in 2013.[2]
Tech is erasing old school rules.
In many ways, Moore’s Law has finally arrived in the oil patch.
Moore’s Law, if you are not familiar, was introduced by Gordon Moore, one of the founders of Intel. In the 1960s he observed that small improvements in technology over time led to a doubling of the density of transistors on a chip each year. The numbers exhibited in the Eagle Ford alone suggest that technology is accelerating the capabilities in oil field production by at least that pace, if not greater.
As the months unfold, advancements in pad drilling and rig mobility, among other breakthroughs, will only ensure more of the same, rendering rig counts as a measure of industry health obsolete.
Wells produce more, faster.
It is not unusual, considering advancements in the way wells are drilled in present day, for production rates at any given site to peak early and yield faster than in the past. The peaks are nearly three times higher than they were just five years ago, creating enhanced production rates, even during decline, due to drilling efficiencies realized by more effective horizontal drilling and hydraulic fracturing practices.
Again, to cite the Eagle Ford as an example, the EIA reports that first-year decline rates in the region fluctuated between 60% and 70% between 2009 and 2013, while second-year rates steadily increased to nearly 50% for wells drilled more recently.[1] A recent Wall Street Journal article supports the notion, stating that EOG Resources Inc. reported 4.3 days to drill an average well in the Eagle Ford Shale, “down from 14.2 days in 2012.”[2]
Clearly, the ability to locate wells that promise higher oil output, combined with the speed at which wells reach peak production, is supporting a quality versus quantity approach to the oil and gas business that can be directly traced to improvements in technology. These advancements make it possible for oil companies to turn a profit, even at today’s depressed market prices, as the cost of producing oil continues to fall in step.
Because you’ve read this far — even more proof of the transformation here.
So have oil prices hit rock bottom?
The question, in light of recent production efficiencies, is moot. Writes Leonardo Maugeri of Harvard University’s Belfer Center, “the truth is that U.S. shale production can be turned on and off almost immediately.” This, according to Pulitzer Prize-winning author, Danie Yergin, positions the U.S. as the world’s new “swing producer,” a tag used to describe Saudi Arabia, for its ability to offset prices fluctuations with a counter in production (effectively “swinging” the market out of a boom or bust).
How are you, as a market player, reacting to the media’s obsession with low oil prices and industry layoffs; falling for the head-fake, or sacking the opportunity while it’s right in front you?
I believe that there will be two camps who emerge from the current industry cycle characterized by depressed oil prices: those who curtail their innovation and shrink their business in lock step with the price of oil (as has been the practice during prior oil busts), and those who take advantage of the opportunity to trim the fat, beef up on technology and position themselves for aggressive growth when the cycle ultimately breaks.
Amp up your trade platform, risk management, and business intelligence technologies now.
Do you have the speed and agility to get your product to market efficiently? Are you able to take a macro view of your transport options and create margin, literally in the margins? Where can you tighten your timelines? Improve operational efficiency? Reduce risk exposure and expand the upside?
This piece originally appeared in OilPrice.com, written by me on behalf of a former client.
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[1] “New Eagle Ford wells continue to show higher production,” by Richard Yan, Jozef Liekovsky and Sam Gorgen, September 29, 2014, U.S. Energy Information Administration.
[2] “Back to the Future? Oil Replays 1980s Bust,” by Russell Gold, January 14, 2015, Wall Street Journal
[1] “All Pumped Up — Oilfield Technology,” by American Oil & Gas Historical Society, AOGHS.org.
[2] “Oil Rig Efficiency Will Fuel A Deeper And Longer Price Decline Than Many Expect,” by Sumit Roy, January 13, 2015, SeekingAlpha.com.
[1] “Jim Cramer Says Oil Prices Are Not Yet at Rock Bottom Levels,” Jim Cramer, January 16, 2015, TheStreet.
[2] “OPEC leader: Oil could shoot back to $200,” by Matt DiLallo, February 3, 2015, CNN Money.
