Fracking FUD from OPEC

There has been a great deal of optimism regarding the future of oil and gas production in North America, and the US in particular.  Fracking has already turned the gas world upside down, and is starting to do the same in oil.  The IEA has made very optimistic forecasts, and the main cloud it sees on the horizon is that the US is not investing enough midstream and downstream to absorb the unexpected upstream bonanza. Citigroup’s oil analysts just released a similarly sunny prognostication.  (I usually don’t see eye-to-eye with Ed Morse on the speculation issue, but he is very credible on the fundamentals of the physical market.)

OPEC is taking a contrarian view in its latest monthly report:

In its latest report, the group of major oil producers forecast the shale boom in the U.S. would help increase oil production by 520,000 barrels a day this year, giving the U.S. the highest production growth among the non-OPEC countries, but it also played down the positive side of these developments by warning of the challenges facing the industry.

“There are remaining risks associated with the growth forecast on the back of weather, technical, environmental and price factors,” the report said. It said that the heavy decline rate associated with the first year of shale oil production from individual wells in the first year was a major factor that could impact growth.

The decline rates are well-known, and E&P companies are basing their drilling investments based on the best available information.  Yes, decline rates could be faster than assumed, but they could be slower too.  Moreover, the technology here is extremely dynamic, and there is a substantial potential for advances in drilling and reservoir management that could make the forecasts of IEA and others appear unduly conservative.   Learning by doing and the accumulation of knowledge on how to exploit fracking technology, generated by the experiences of numerous companies, lay the foundation for positive productivity shocks.

OPEC’s sour attitude on unconventional oil bears an uncanny resemblance to Gazprom’s initial reactions to shale gas, reactions that were hardly persuasive early in the boom, and which look more pathetic by the day.

It seems that like Gazprom, OPEC is trying to spread Fear, Uncertainty, and Doubt about unconventional oil, in an attempt to try to scare off investment.  Their efforts are likely to be no more successful than Gazprom’s.  The people committing the capital know more about fracking and the formations where it can be used than OPEC, and are learning more every day.

And while we’re on the subject of OPEC and uncertainty, perhaps it could address things it might actually know a lot about, like the reliability of Saudi reserve estimates and the effects of political risk on production in places like Venezuela and Nigeria.

About Craig Pirrong 223 Articles

Affiliation: University of Houston

Dr Pirrong is Professor of Finance, and Energy Markets Director for the Global Energy Management Institute at the Bauer College of Business of the University of Houston. He was previously Watson Family Professor of Commodity and Financial Risk Management at Oklahoma State University, and a faculty member at the University of Michigan, the University of Chicago, and Washington University.

Professor Pirrong's research focuses on the organization of financial exchanges, derivatives clearing, competition between exchanges, commodity markets, derivatives market manipulation, the relation between market fundamentals and commodity price dynamics, and the implications of this relation for the pricing of commodity derivatives. He has published 30 articles in professional publications, is the author of three books, and has consulted widely, primarily on commodity and market manipulation-related issues.

He holds a Ph.D. in business economics from the University of Chicago.

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