Features Australia

Slippery oil industry

8 December 2018

9:00 AM

8 December 2018

9:00 AM

When oil prices spiked to $US140 ($A193.85) a barrel in 2008, veteran analysts declared that prices would reach $US200 or even $US300 a barrel, only for the market to promptly collapse. To this day no-one is quite sure why prices spiked or collapsed.

Given that experienced analysts are often completely wrong about what will happen to the market, it is little wonder that the Australian Competition and Consumer Commission and long-suffering Australian motorists are often mystified by price variations at petrol bowsers.

But the rise of the American fracking industry, a subject which causes climate activists to froth at the mouth, may reduce the volatility of crude oil prices, although whether that helps at Australian petrol stations is another question.

The most commonly offered explanation for the 2008 boom and bust is that the oil industry is easy to unbalance through interruptions to supply, which may be a number of factors working together rather than a major, newsworthy event. Prices also have a tendency to boom and bust even without changes in the industry.

It should follow, however, that restrictions on supply due to sanctions on Iran and Venezuela’s self-imposed melt-down should boost prices, and for a time the oil industry followed script. Prices came off lows of below $US40 in early 2016 to get above $US76 (to use the benchmark West Texas Intermediate price index) in early October. The ongoing problems of major oil-producer Libya did not help. Then prices started falling to drop to almost $US50 a barrel in late November, before a slight recovery, with President Trump promptly claiming credit for the fall despite his administration demanding sanctions against Iran over that country’s nuclear program. President Trump abandoned a deal with Iran over that program saying that it was not in his country’s interests.

A bulletin issued by the US Energy Information Agency in November, however, states that the US is now producing 11.6 million barrels per day of crude oil, up from an average of 9.4 million in 2017, with the expected average to climb to 12.1 million a day in 2018.

The vast bulk of this increase came from fracking prompted by the increase in oil prices. To put that in perspective, the previous production peak for US oil from conventional wells was about 10 million barrels a day in the 1970s. Production in Russia, now the largest oil producer outside the US, is about 11 million barrels a day.

This astonishing production success is a world away from the doom and gloom of peak oil forecasts during the price spike of 2008, and has been achieved without any noticeable changes to American farmland, despite yet more warnings of disaster. The real loser has turned out to be the Organisation of Petroleum Exporting Countries with lead member Saudi Arabia and others failing in efforts to drive American fracking out of business, partly due to the ability of those operating in a free market to innovate and adapt.

Conventional oil production involves drilling a hole in what geologists hope is the right place to hit an underground reservoir. When it works, and depending on circumstances, the oil can be extracted for as little as $US10 a barrel, with the well taking years to set up and remaining in place for many more years. Fracture cracking is more complicated as it extracts oil trapped in rocks.

Material including chemicals and sand is forced down the hole in order for oil and gas to be forced up, so operating costs are higher – initially more than $US70 a barrel.

Saudi Arabia and others then tried to get rid of this new competitor by increasing production in order to drive prices down. The fracking industry responded by cutting production but also by introducing new technology and approaches which drove costs down to below $US40 a barrel, with the resulting wafer-thin margins proving enough to keep the debtors of the survivors at bay.

Now that prices are up again those survivors have deployed the rigs left over from the last cycle as these are typically mobile, can take just weeks to set up, and remain in place for a far shorter time than those used to extract oil from reservoirs. They also have a much higher success rate than traditional wells. It seems that oil and gas can be found in most areas.

All this means that the oil industry has a new cycle. When oil prices are down the fracking sector starts mothballing drilling rigs, but when prices rise those rigs are deployed again, constraining prices. Opec’s hold on the market has been seriously weakened.

Fracking can occur anywhere, but in the United States the best areas already had an existing network of pipelines for transporting crude, and for trucking in the material required.

In the US legal system, those owning the land hold the mineral rights so they get a slice of the profits which can add up to life-changing amounts, prompting noticeably less opposition from farmers and communities. In Australia the state governments hold the mineral rights on behalf of the community so unless the drilling rig is on their land (fracking rigs drill vertically for long distances) farmers don’t get anything.

Much of the resistance to fracking in rural areas (in contrast to the ideological opposition by greens from the cities) can be traced to that issue.

In any case, most of the necessary infrastructure built in Australia is for well-established coal seam gas which can be expanded provided communities get over their fears about the different technique of fracking.

The Northern Territory has opened up large areas to potential development of fracking, but those areas do not have the infrastructure which has made fracking possible in the US. Unlike conventional, long-lasting wells, the economics of building the necessary roads and pipelines are less attractive. Circumstances have again favoured American enterprise.

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