Here, there be dragons

We are approaching the end of 2016, and here, there be dragons. The “lower-for-longer malaise” has settled in place, and the longer we stay below a stable global price of $65/bbl, the more pressure that is placed on companies to tighten their belts and show shareholders fiscal efficiency. If your company has focused exclusively on onshore unconventionals, you are likely feeling lots of pain. In the Bakken play, for example, the rig count has dropped from 203 units in 2012 to 30 in October 2016. The loss of rigs is, of course, reflective of lost jobs and a reduction of capital investments.

Trends. There have been many oil price collapses over the years, and these events are typically driven by global geopolitical factors. Historically, these conditions tend to correct within a couple of years. But the current lower-for-longer situation is unique, as world oil demand has slowed in response to a slowing global economy, and the supply of crude remains high.

Many operators continued to drill new wells during this period, but they delayed their completion in an attempt to reduce spending, build a quick inventory, and be ready to take advantage of a recovering commodity price in the future. However, when the oil price does begin to recover, this backlog of drilled-but-uncompleted wells will be a counterforce, holding down crude prices in the short term, until the backlog is worked off.

Thanks to the success of unconventional plays, the United States has become the world’s largest producer of natural gas and has recently exceeded Saudi Arabia and Russia in combined production of oil and natural gas liquids, with daily output exceeding 11 MMbpd. OPEC may have perceived this as a threat, and the cartel pushed into a strategy of keeping crude output high, thus helping to suppress the global oil price. Perhaps it was intended to drive the unconventional plays into an early grave. But if that is so, the plan backfired—for the dragons were slain by the unconventional entrepreneurs. These modern dragon-slayers were able to adapt to the artificially low price environment by cutting rigs, capital programs, and unfortunately, the jobs of many talented people.

Efficiency reigns. While OPEC expected this to be the nail in the unconventional coffin, our dragon-slayers wielded a new weapon to improve efficiency. Applying this weapon of lean principles, our dragon-slayers were able to do more with less, and reduce waste in all aspects of the value chain. In some cases, they reduced drilling and completion costs by half, by significantly reducing cycle time, streamlining operational processes, improving the supply chain, and keeping production at least flat, despite the lowering of rig count. These actions contributed to a significant decrease in a break-even price for most U.S. shale plays. This spirit of entrepreneurship that the modern dragon-slayers exhibited was something that OPEC did not expect.

A recent announcement of an increased rig count in the Permian basin, and the use of enhanced oil recovery methods in the Eagle Ford shale, are just a couple of examples of applying lean principles and innovation to not just survive, but to thrive in this low-price environment. The pressure on OPEC has been profound, and in October of this year, Saudi Arabia’s energy minister delivered a message to fellow cartel members, saying that the time is now right for OPEC to retake control of the market, arguing that allowing prices to slide for two years was now causing “unhealthy” damage to future production.

Investment creates value. The floundering oil price environment further led our dragon-slayers to realize an opportunity. With lower rig activity, there was now time to dig deeper into the science underpinning unconventional plays, and focus research and technology investments on targeted areas. It is true that large-scale funding grants to engineering and geoscience programs at universities have been cut significantly, to preserve liquidity, but even in these challenging times, some investment in focused project-based research and technology development can create value.

The risk of not making such investment in engineering and geoscience programs is to repeat history and exasperate the “great crew change.” The advantage of supporting these programs is to accelerate extraction of value from unconventional plays while educating the next generation of talented petroleum professionals, who will lead our industry forward as the commodity price improves.

Investment in people and innovation will create a competitive advantage for companies that position themselves as leaders after the dragons are slain. Yes, there be dragons here, but with an entrepreneurial spirit, investment in technology, and preservation of human capability, the industry will continue to slay the dragons.