Chris Faulkner: Case For a Crude Oil Boomerang

The story didn’t get much attention when Bloomberg broke it Monday afternoon last week, but now it seems to have hit all the big majors, including CNN Money as late as today.  OPEC’s Secretary General Abdulla al-Badri said oil could return to $200 per barrel.  Harold Hamm, Continental Resources CEO was also quoted last week saying oil could at least top $100 soon, for the same reason:  Shale depletion curves will eventually catch up with falling investment in new production.  When that happens, there will be a supply shortage.

What’s been missing from the media’s coverage is the connection of why this is happening, and precisely why Mr. al-Badri was allowed to make such a claim.  After all, why would OPEC let its top administrator jawbone public commentary like that, especially now?

First, the headline:  Shale wells decline quickly.  In the industry, we typically project no more than a 3-year payback, then we’re happy to get the tail production for the next two, three or more decades.   Last week, Baker Hughes reported the single largest drop in working oil and gas rigs in over three decades, as 90 rigs fell silent.  Counting the 49 offshore rigs and 12 inland platforms in the tally, the total number of rigs working as of January 30, 2015 in the U.S. is 1,543.  The number peaked the week of September 12, 2014 at 1,931; so 388 rigs have thus far stopped working.

Contrast that with the weekly supply numbers reported by the Energy Information Administration.  The last data from January 23, 2015 reflects 9.213 million barrels per day, the most oil produced from American soil since the agency started tracking this in 1983.  Obviously, production has not caught up with the slowdown in rigs, but eventually it will.  Supply numbers are still reflecting how prolific the oil boom is, or was.  Even a reduction of 20-percent of the working rigs has resulted in a production increase.  That’s the definition of prolific.

The steep decline of shale well output will eventually show up in the reports, and the weekly output number will precipitously decline.  When that will happen is anyone’s guess.  Rigs didn’t start slowing in earnest until mid-December, so we could still be months away from softer production numbers.

Here’s the scenario most are not talking about:  Rigs will continue to lie down.  That’s what Mr. al-Badri meant when he spoke of less investment.  Simultaneously, production will eventually slow down.  When it does, the United States will be in a supply deficit.  At that point, Mr. al-Badri, Mr. Hamm and even Mr. Pickens should be right.  Prices could shoot back up quickly.

What is more alarming is what OPEC is likely to do, or not do, about that shortage.  Throughout this decline, Saudi Arabia has held firm, and dragged the rest of OPEC with them, that there’s no budging on the 2011 quota agreement of 30-million barrels per day.  As U.S. production increased, they had to find other sources for that oil.  China and the Pacific Rim, Europe, other destinations in the Middle East, have absorbed all but approximately 2 million barrels of oil that was formerly America-bound.

When production finally slows domestically, the looming question is whether OPEC will re-direct shipments, or whether the U.S. could face a self-induced supply shortage?  There certainly won’t be enough new rigs drilling to fill the void quickly, and we’ve already seen it could take years to ramp this back up to where we were two weeks ago.

Thus, the United States could again find itself subject to OPEC’s mood swings.  If the impending void doesn’t get filled from somewhere, supply shortages could be substantial enough to jeopardize daily requirements, which would certainly create upward pressure on prices.  In 1973, Saudi imposed a 400-percent price hike to a whopping $12 dollars per barrel.  If that happened again, there’s the $200 number, based on today’s levels.

At this point, nobody is estimating how much current production might drop, and there’s no way to predict how many rigs will eventually find themselves on temporary hiatus.

Could that be why OPEC allowed its version of an office manager to float out a scenario of oil paralysis coming soon?  If it wasn’t for the level of disdain between Riyadh and Washington these days, such a scenario might not even seem plausible.

Written by: Chris Faulkner, CEO of Breitling Energy Corporation and author of the recent book, “The Fracking Truth.” He is also the producer of the documentary, “Breaking Free: The Shale Rock Revolution.”