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Rising US Oil Supply And How Innovation Never Stands Still

Business, Company Strategy, Oil & Gas
By John Richardson on 21-Apr-2015

By John Richardson

Georgemitchell2NECESSITY is the mother of new inventions, and also of innovations that make improvements on old inventions.

When, for example, oil and gas prices were sky-high in the US, this prompted the late and great George Mitchell (see right) to persist with research that led to modern hydraulic fracturing techniques.

Now we are in an altogether different world, thanks to the 50% or so collapse in oil prices since H2 of last year.

If you disagree with my opening statement then, sure, side with the analysts who still think that the collapse in crude prices will inevitably result in an equally big and long-term reduction in US oil production.

But if you instead agree that there is a constant link between necessity and scientific and technological breakthroughs, as the George Mitchell story so perfectly illustrates, then assume exactly the opposite as one scenario. I think we could instead well see a world where US oil and gas production increase rather than decrease over the long term.

The underlying reason is that the economic, social and political necessities that led to George Mitchell’s fracking revolution look altogether different today than seven years ago.  America, because of its fracking revolution, now finds it necessary to:

  • Find a way of repaying the $1.2 trillion that has been leant to US oil and gas companies over the last five years alone. This is bigger than the size of the Australian economy.
  • One way to deal with this debt is to allow a great deal of “creative destruction” – i.e. by allowing energy companies, and banks and other lenders that financed these companies, to go bust in a number perhaps reminiscent of the number of bankruptcies during the Great Depression.
  • But this will not be allowed to happen today anymore than it could have been allowed to happen in 2008. Some will debt will be written off, but lenders will also have to be sufficiently compensated to avoid a financial-sector crisis.
  • And whilst this process goes on, very few oil and gas companies will be willing to shut down production. A few dollars of returns on each barrel of oil produced are better than no dollars at all when you have large liabilities to meet.
  • We also know that much of the job creation in the US, and a large proportion of its supposed housing recovery, is down to oil and gas. So Federal and State governments run by both major political parties are likely to provide lots more financial incentives designed to keep the energy industry healthy.

As a result, innovation in fracking will accelerate.

We have already seen US frackers learning to do “more with less” – i.e. getting greater productivity out of the fewer number of wells that are now in operation  (see the chart below).


“Fracklog” is also happening, whereby many wells have been sunk but with their oil and gas yet to be extracted. This is in effect another form of storage, ready for when the economics of fracking further improve and/or when oil prices recover.

What’s next, then? As The Economist writes in its latest edition, work continues on improving seismic data, which is making more individual “fracks” successful, as the ability to drill ever-more wells from a single spot also improves.

And on the horizon is the use of polymers and other fluids that might cut water use or even eliminate the use of water altogether, adds The Economist. One of the main impediments to further production growth in the US is the large amounts of water required for existing fracking techniques.

US frackers have also been able to trim costs because the prices of labour, steel and other inputs have fallen. The Economist sees these as “one-off benefits” to the US energy industry, but I disagree. Here is why:

  • The $1.2 trillion that has been borrowed by US oil and gas companies since 2010 is just the tip of a global debt iceberg. Vast amounts of money have also been leant to oil and gas, chemicals and iron ore companies etc. all over the world.
  • The money was leant because too many people misread the real, sustainable strength of the global economy These are the same people who are now holding their hands up in surrender whilst pleading, “Black Swan, Black Swan, nobody saw this coming”.
  • So now we face a prolonged period of global deflation. This will enable US frackers to continue to cut costs.

I can, though, already almost hear the sceptics say “geology, geology”. They will argue that US shale oil and gas fields deplete more rapidly than some shale bulls think, resulting in reserves being overstated.

Globally, we were supposed to be running out oil because of geology – remember the Peak Oil theory? This hasn’t happened because of technological breakthroughs.

Let’s assume for arguments sake, however, that the US starts to run out of shale oil and gas quicker than can be fully compensated for by the pace of innovation.

Bu there are still the rest of the world’s shale reserves. The US can always boost its geopolitical influence, gain access to lots of overseas hydrocarbon reserves and generate loads of economic value by exporting its constantly improving fracking expertise.