The last barrel

As February drew to a close, the near-term outlook for the upstream industry continued to look murky—I’m trying to be polite, but a somewhat stronger word could apply.

Talk of a potential production freeze—led by Russia and Saudi Arabia—dominated industry headlines for much of the month and briefly raised the hopes of beleaguered workers across the globe. While space and the evolving nature of the proposed freeze preclude a detailed analysis here, the plan presently appears to be about as helpful as a chocolate fireguard.

Lest we forget, the Saudis and the Russians are already pumping crude at elevated levels. Meanwhile, Iran remains committed to flexing its crude-pumping muscles and isn’t in the mood to curb anything, as it looks to reclaim market share—everyone’s favorite word. And, even if a production freeze is agreed upon and brought into force, all that would be achieved is an official entrenchment of current overproduction.

What the upstream industry really, really needs is cuts, which would, slowly but surely, lead to a resurgence in oil prices and a drawdown on crude stockpiles. Unfortunately, the Saudis have been abundantly clear that this isn’t going to happen, even referring to the idea as a waste of time.

While there have been some shut-ins to date, according to a new analysis by Wood Mackenzie, we have a lot further to go before the market comes back into balance. According to the consultancy, since prices began to fall in late 2014, only about 100,000 bopd have actually been shut-in. Just in case, dear reader, the true insignificance of that number wasn’t clear enough, Wood Mac was kind enough to point out that this equates to less than “0.1% of global production.” Thanks for that.

And to make matters worse, the consultancy cautions that the number of shut-ins is unlikely to increase at the rate that some might expect, as many producers hold out, in the hope of a price rebound.

Naimi’s perspective. Still, any hope of a sustainable, near-term price rebound took a hit toward the end of February, when Saudi Arabian Minister of Petroleum and Mineral Resources Ali Al-Naimi took to the stage at IHS CERAWeek in Houston, and threw down the proverbial gauntlet to a large roomful of U.S. oilmen.

During his keynote address to the conference, Naimi went on record—again—to say that OPEC and its de-facto leader, Saudi Arabia, hasn’t “declared war on shale, or on production from any given country or company; contrary to all the rumors you hear and see.”

As Naimi told assembled business leaders, $100 oil led to the development of resources—such as Canada’s oil sands, Venezuela’s Orinoco belt and, surprise, surprise, shale—that were previously uneconomic.

The minister, who is arguably the world’s most influential oilman, warned the representatives of such high-cost production that, if they wish to survive, they must find a way to “lower costs, borrow cash or liquidate.” “It sounds harsh, and unfortunately it is, but it is the most efficient way to rebalance markets,” he added.

That’s quite a bold statement to make in Houston, given the depth of cuts already exacted by operators and service companies across North America. But, in my opinion, and please don’t lynch me, Naimi is correct in the strictest sense of the word—this war isn’t just about shale.

Saudi Arabia declared war on shale, on the North Sea, on Canada’s oil sands, on the deepwater fields offshore Brazil and even on oil from fellow OPEC member Venezuela, when it led the charge and refused to cut production in November 2014.

However, as shale accounted for such a significant amount of the new production brought onstream over the preceding years, it is inconceivable that shale didn’t weigh heavily on the thoughts of everyone’s favorite cartel, when it refused to cut production. The Saudis may not have explicitly declared war on shale, but, in letting the market (and, in turn, lifting costs) decide, that is what happened. It’s a war of attrition.

Naimi also said that he hoped the nimbleness of shale operators would continue, saying that their production will be needed, once the market comes into balance and supplies constrict.

While the U.S. shale industry has proved remarkably resilient so far, the lower-for-longer oil price scenario has, month-by-month, been taking a toll on the industry. And the longer prices stay low, the harder it will be for shale producers to recover.

After all, the wholesale layoffs—by both service companies and operators—will hamper the ability of companies to ramp up activity quickly. And even if they try, it remains to be seen whether these companies will be able to attract enough laid-off workers back into an industry that, at times, resembles a rather wild rollercoaster. And, lest we forget, it takes a lot of capital to drill and complete wells—how quickly will investors be willing to run back into the breach?

It should be obvious, by now, that the North American upstream industry can’t expect any help—either from the U.S. federal government, which has a default position of making life harder for the industry, or from OPEC/Saudi Arabia. Unlike the banks, which were considered too big to fail, many in positions of power in the U.S. would be more than happy to stand idly by and watch the downfall of shale operators—the bigger fall, the better (if you doubt the hostility of the feds, take a look at President Obama’s proposed $10.25/bbl oil tax).

Ultimately, shale will live to fight another day. The industry has only one choice, only one way forward. Companies have to innovate, collaborate, and standardize, and to develop new technologies and new ways of working, which will help to find and extract oil in a manner reflective of the new oil-price reality.