US has potential to be world’s biggest oil producer

« When you invest in energy assets, you are making a bet on human ingenuity,” says Katherine Richard, chief executive of Warwick Energy Group, an Oklahoma-based oil and gas company. Her point is that while outsiders often focus on resources in the ground, inside the industry there is just as much, if not more, attention paid to human ingenuity. Reserves are important, of course, but what really counts is the insight to understand what is there, and the creativity to be able to extract it in a commercially attractive way.

When Apple surpassed ExxonMobil in market capitalisation, some commentators contrasted what they saw as the relentless innovation of the information technology industry with the sluggish traditionalism of the oil and gas business. In reality, innovation is central to the oil and gas industry, as the past half-decade has conclusively demonstrated. Five years ago, US oil production seemed on course to enter its fifth successive decade of steady decline, as the wells that had made it the world’s largest producer steadily ran dry. Since 2008, though, there has been a dramatic reversal. US production has risen by 50 per cent, cutting the share of imports in the country’s oil supply from over 60 per cent to under 40 per cent. By the end of the year, the US is set to cede its position as the world’s largest oil importer to China.

Many forecasters suggest the trend is set to continue. The International Energy Agency, the rich countries’ oil watchdog, predicts that before the end of the decade the US could be the world’s largest oil producer. Over the next five years, it is expected to account for about a third of all the new oil coming on to the market worldwide. The difference has been advances in the techniques of hydraulic fracturing and horizontal drilling. Neither of them is exactly new, but both have been developed to higher levels of sophistication, and combined to remarkable effect to open up shale reserves, first for natural gas and then increasingly for oil. The US has been the natural cradle of this revolution. Wide open spaces and a long history of extensive onshore oil and gas development have limited the objections to the disruption caused by the procedures of drilling and fracking. Legal systems that generally allot mineral rights to landowners, rather than to governments, have created financial incentives for them to allow oil and gas companies on to their property.

As Ms Richard points out, America’s history of oil and gas extraction has also blessed it with a rich endowment of geological data. The oil held in shale reserves – sometimes known as “tight oil” – has been known about for a long time. The challenge has always been to get it to flow out at rates that make drilling a well a commercially viable investment. Now that challenge has been solved. In a direct parallel with the technology industry, the big success stories of the shale revolution have not been Exxon and Chevron, the established titans of the industry, or foreign companies with large American investments such as BP and Royal Dutch Shell. Instead, it has been smaller independent companies such as Continental Resources, EOG Resources, Whiting Petroleum and Pioneer Natural Resources that have been nimble enough to spot the new opportunities, secure them by signing drilling leases in the most productive areas, and then develop them. However, some analysts have begun to wonder whether the companies that have led the US shale oil revolution may be about to run out of steam.

Most of the growth so far has been concentrated in just two areas: the Bakken shale of North Dakota and the Eagle Ford shale of south Texas. Production is still growing in North Dakota, but no longer at the spectacular pace of a year ago. Analysts at Sanford Bernstein argue that the newer shale regions now being opened up, including those in the Permian Basin of west Texas, have not matched the productivity of the Eagle Ford and the Bakken. Peak production from new oil wells in the Bakken has actually fallen since 2010, they say, while peak production from Eagle Ford wells has been flat. At the same time, however, producers are driving down the cost of their wells by using techniques such as “pad drilling”: sending multiple wells radiating off in diferent directions from a single site.

William Thomas, chief executive of EOG Resources, said on a call with analysts last month to discuss the company’s second quarter results that it had cut the average cost of a well in the Eagle Ford shale from $6m to $5.5m. The longer-term outlook for the industry will be decided by that battle between geology and human ingenuity. For the time being, though, an oil price well above $100 per barrel, thanks to the tensions with Syria and supply disruptions in countries such as Libya and Nigeria, makes the returns on US oil production still look attractive. “We probably need to have $90-plus oil prices to continue this growth,” says Scott Hanold, an analyst at RBC. “Certainly at $100 we can do it.”

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