The Real Cause Of Low Oil Prices: Interview With Arthur Berman

With all the conspiracy theories surrounding OPEC’s November decision not cut production, is it really not just a case of simple economics? The U.S. shale boom has seen huge hype but the numbers speak for themselves and such overflowing optimism may have been unwarranted. When discussing harsh truths in energy, no sector is in greater need of a reality check than renewable energy.

In a third exclusive interview with James Stafford of Oilprice.com, energy expert Arthur Berman explores:

• How the oil price situation came about and what was really behind OPEC’s decision
• What the future really holds in store for U.S. shale
• Why the U.S. oil exports debate is nonsensical for many reasons
• What lessons can be learnt from the U.S. shale boom
• Why technology doesn’t have as much of an influence on oil prices as you might think
• How the global energy mix is likely to change but not in the way many might have hoped

John Brynjolfsson Oil Supply Arthur Berman

 

OP: The Current Oil Situation – What is your assessment?

Arthur Berman: The current situation with oil price is really very simple. Demand is down because of a high price for too long. Supply is up because of U.S. shale oil and the return of Libya’s production. Decreased demand and increased supply equals low price.

As far as Saudi Arabia and its motives, that is very simple also. The Saudis are good at money and arithmetic. Faced with the painful choice of losing money maintaining current production at $60/barrel or taking 2 million barrels per day off the market and losing much more money—it’s an easy choice: take the path that is less painful. If there are secondary reasons like hurting U.S. tight oil producers or hurting Iran and Russia, that’s great, but it’s really just about the money.

Saudi Arabia met with Russia before the November OPEC meeting and proposed that if Russia cut production, Saudi Arabia would also cut and get Kuwait and the Emirates at least to cut with it. Russia said, “No,” so Saudi Arabia said, “Fine, maybe you will change your mind in six months.” I think that Russia and maybe Iran, Venezuela, Nigeria and Angola will change their minds by the next OPEC meeting in June.

We’ve seen several announcements by U.S. companies that they will spend less money drilling tight oil in the Bakken and Eagle Ford Shale Plays and in the Permian Basin in 2015. That’s great but it will take a while before we see decreased production. In fact, it is more likely that production will increase before it decreases. That’s because it takes time to finish the drilling that’s started, do less drilling in 2015 and finally see a drop in production. Eventually though, U.S. tight oil production will decrease. About that time—perhaps near the end of 2015—world oil prices will recover somewhat due to OPEC and Russian cuts after June and increased demand because of lower oil price. Then, U.S. companies will drill more in 2016.

OP: How do you see the shale landscape changing in the U.S. given the current oil price slump?

Arthur Berman: We’ve read a lot of silly articles since oil prices started falling about how U.S. shale plays can break-even at whatever the latest, lowest price of oil happens to be. Doesn’t anyone realize that the investment banks that do the research behind these articles have a vested interest in making people believe that the companies they’ve put billions of dollars into won’t go broke because prices have fallen? This is total propaganda.

We’ve done real work to determine the EUR (estimated ultimate recovery) of all the wells in the core of the Bakken Shale play, for example. It’s about 450,000 barrels of oil equivalent per well counting gas. When we take the costs and realized oil and gas prices that the companies involved provide to the Securities and Exchange Commission in their 10-Qs, we get a break-even WTI price of $80-85/barrel. Bakken economics are at least as good or better than the Eagle Ford and Permian so this is a fairly representative price range for break-even oil prices.

But smart people don’t invest in things that break-even. I mean, why should I take a risk to make no money on an energy company when I can invest in a variable annuity or a REIT that has almost no risk that will pay me a reasonable margin?

Oil prices need to be around $90 to attract investment capital. So, are companies OK at current oil prices? Hell no! They are dying at these prices. That’s the truth based on real data. The crap that we read that companies are fine at $60/barrel is just that. They get to those prices by excluding important costs like everything except drilling and completion. Why does anyone believe this stuff?

If you somehow don’t believe or understand EURs and 10-Qs, just get on Google Finance and look at third quarter financial data for the companies that say they are doing fine at low oil prices.

Continental Resources is the biggest player in the Bakken. Their free cash flow—cash from operating activities minus capital expenditures—was -$1.1 billion in the third- quarter of 2014. That means that they spent more than $1 billion more than they made. Their debt was 120% of equity. That means that if they sold everything they own, they couldn’t pay off all their debt. That was at $93 oil prices.

And they say that they will be fine at $60 oil prices? Are you kidding? People need to wake up and click on Google Finance to see that I am right. Capital costs, by the way, don’t begin to reflect all of their costs like overhead, debt service, taxes, or operating costs so the true situation is really a lot worse.

So, how do I see the shale landscape changing in the U.S. given the current oil price slump? It was pretty awful before the price slump so it can only get worse. The real question is “when will people stop giving these companies money?” When the drilling slows down and production drops—which won’t happen until at least mid-2016—we will see the truth about the U.S. shale plays. They only work at high oil prices. Period.

OP: What, if any, effect will low oil prices have on the US oil exports debate?

Arthur Berman: The debate about U.S. oil exports is silly. We produce about 8.5 million barrels of crude oil per day. We import about 6.5 million barrels of crude oil per day although we have been importing less every year. That starts to change in 2015 and after 2018 our imports will start to rise again according to EIA. The same thing is true about domestic production. In 2014, we will see the greatest annual rate of increase in production. In 2015, the rate of increase starts to slow down and production will decline after 2019 again according to EIA.

Why would we want to export oil when we will probably never import less than 37 or 38 percent (5.8 million barrels per day) of

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