Crude Observations

Is it really as bad as it seems?

This past week I have found myself engaged in a fair amount of soul-searching. And not surprisingly, I have found on further reflection that I have spent a disproportionate amount of time in recent weeks (OK, months) piling on Canada and pointing out the foibles, weaknesses, regulatory hurdles, lack of capital infrastructure woes and other flaws in the Canadian energy sector. And truth be told, I feel kinda bad about it. I mean it’s my country right?


I know that many of the Canada criticisms are well-earned and deserved and everyone likes a bit of self-flagellation every now and then. And of course it is highly fashionable these days to mock Canada when you consider the inter-provincial trade war between BC and Alberta, disastrous foreign trips, convicted terrorists being invited to galas, the dumpster fire that is the Ontario Conservative Party, the future of NAFTA and a Federal government that you increasingly get the impression is just not being taken seriously. On top of that, there’s Olympic curling and hockey. It’s almost a national crisis.


But if you, like me, ascribe to the saying that it is always darkest before the dawn, you may find yourself looking in some pretty odd places for some good news.


This is why for the past few days I have been trying to focus on other regions and see if after some cursory analysis and wildly speculative assumption there isn’t a case to be made for Canadian energy after all, provided we can sort out our infrastructure “issues”.


So here goes nothing – a roundabout case for the Canadian energy industry.


The obvious place to start is in the United States where the shale tail is wagging the energy dog or something like that.  Tortured I know, but you can’t talk about oil and energy without talking about shale or tight oil. And you can’t talk about tight oil without talking about politics and hype. Put another way, the hype about tight oil in many ways is driving US energy policy. Not everyone thinks this is a good thing. But it could ultimately be good for Canada – is we can see fit to get our act together.


Aside from the corporate hype, in its recently issued Annual Energy Outlook, the Energy Information Administration in the United States (EIA) laid out its most optimistic projections for US oil production yet, driven entirely by tight oil.


Rising from a base of 10.2 million barrels per day at the end of 2017, the EIA in its reference case projects that US oil output would increase to in excess of 12 million barrels of oil per day through 2030 and beyond, decreasing marginally past 2040. This is a monumental rise for an industry that was basically in terminal decline just over a decade ago.


All of this increase in production has come from and is expected to continue to come from tight oil, primarily the prolific Permian Basin which is expected to account for some 40% of US tight oil production or well in excess of 3 million barrels per day.


All told, tight oil production at the 12 million barrel per day production level is expected to be about 8-9 million barrels per day by 2050. By contrast, Canada, which currently produced about 4 million barrels per day is expected experience much more modest growth.


If you’re a Canadian producer and you look at these numbers, it’s sure easy to get discouraged. I mean seriously, what’s the point in developing any long lived oil sands assets when there is a veritable tsunami of tight oil coming out of West Texas and North Dakota?


But look under the hood for a bit and tinker around and you start to notice that there are a lot of after-market parts and more than a fair share of twist ties, rubber bands and duct tape holding the engine together. Put another way, there are a lot of assumptions in those numbers and a lot has to break right for them to happen.


There is no argument to be made that US tight oil hasn’t revolutionized a fairly large sub-segment of the oil industry – it has. This is particularly true in what you could call the short cycle portion. Short cycle oil is drilling activity that can be ramped up and down rapidly in response to price movements, smaller wells that are quick to market responding solely to price. They can turn a quick buck, meet a demand need and if you can drill enough of them, you can affect the market.


Really, the genius of tight oil isn’t that it is some form of swing producer – it isn’t – no, the genius is that tight oil producers have taken previously abandoned or in terminal decline plays and rocks with lousy economics and made the economics slightly less lousy through the application of new technologies, cost suppression and access to limitless amounts of yield seeking capital. On top of that, the hype surrounding shale may in fact be one of the most elegant cons in the energy sector – taking in bureaucrats, politicians, energy company managements, private equity and Wall Street.


Look, I’m deliberately exaggerating for effect, but much like the oil and gas income trust in Canada was the world’s only legalized Ponzi scheme (man, I still love that quote), much of the hype surrounding tight oil reminds me of a Jenga game. It’s risen so high that each time you tap it you think it’s finally going to crash, but you manage to keep adding layers, but at some point, you know it’s coming down and you hope you aren’t the one holding the last block.


Seriously though, I’m not the only one thinking about this. There is a whole shale skeptic sub-culture populated by some really smart people who think the hype is way overdone, the production numbers from the EIA are poppycock and that 4 years of underinvestment in upstream exploration and development anywhere outside of North America is setting up a supply crunch.


Anyway, I digress, back to tight oil.


I recently read a really interesting study written for the “Post Carbon Institute” that assessed the practical realities of hitting the EIA’s reference case. It did this by doing an individual well, county by county review of each major tight oil and shale gas play to create what is in essence a bottom up reality check on these projections to determine whether, given the fact set as it currently exists, the projections were pessimistic, optimistic or just plain bonkers..


The numbers and conclusions are startling to say the least and cause for sober second thought. Some of the highlights:


  • US tight oil plays in general have high decline rates, with production from individual wells falling between 70% and 90% in the first three years and field declines ex-new drilling generally in the range of 20% to 40% per year. If you are skeptical of that, consider that between 2016 and 2017, US production fell by 1.1 million barrels per day or just over 12%, but the lion’s share of that decline was in the half of US production represented by tight oil at that time, so close to 20% decline. The message in that? You need to drill and complete a lot of wells just to tread water.
  • A lot of the tight oil plays that everyone talks about are geographically huge and cover in some cases thousands of square miles. However, the most productive wells tend to be concentrated in “sweet spots” and it is in these sweet spots that much of the drilling activity has already occurred – a process known as high-grading. These sweet spots tend to be relatively concentrated, making up on average 10% to 20% of the play. Why drill the sweet spots? Remember the short cycle comment. It’s all about maximizing current return.
  • Drilling in sweet spots and the application of better technology has achieved big increases in productivity as wells are being drilled longer and are using more proppant to coax more molecules out of individual wells. The result is fewer and longer wells being drilled more aggressively, costing less and producing more. Good right? Except this doesn’t change the amount of product recovered from a play, it just recovers it faster! Short cycle!
  • Although initial productivity is higher because of these longer and more aggressively fractured wells, the data suggest that it has plateaued in many places indicating that geographic limitations to sweet spots may have been reached. This does not even consider the impact of “frac hits” from wells being drilled in close proximity.
  • To meet the aggressive projections of the EIA, the study projects that 100% of proven reserves in all tight oil plays and a substantial portion of unproven reserves (in some cases more than 100%) will need to be recovered in the projection period, not to mention that at the end of the projection period, production is expected to be at least as high as it is today meaning substantial as yet to be accounted for reserves will need to be found. US reserves are currently estimated to be about 10 to 40 billion barrels depending on the method used. To meet the EIA reference case projection, more than 75 billion barrels need to be produced just to meet production from 2018-2050 never mind after that. There is a large unproven amount implicit in the assumptions.
  • Ignoring shale gas for the moment, using county by county data and individual well statistics and a typical cost for drilling and completing a well (and assuming that it doesn’t change), the study estimates some 1.3 million wells will need to be drilled at a cost of close to $7.5 trillion. Annually, this amounts to an average of $250 billion a year and in excess of 40,000 wells.


There is no doubt that US tight oil has revolutionized and revitalized the US energy industry, but the numbers above appear to be unachievable and unsustainable given the vagaries of capital markets, service sector costs and the nature of rocks.


Consider that in the period from 2011 to 2014 – prior to the oil price collapse, American tight oil companies spent in excess of $500 billion, had twice as many rigs drilling as today amounting to about 35,000 wells a year and added an estimated 3 million barrels of oil per day in production. It seems almost plausible to think that why can’t they replicate that again until you start to consider all the land issues, cost inflation, offtake capacity constraints, rising finance costs. Never mind the fact that the tight oil industry as a whole has managed to produce negative free cash flow since the beginning – encompassing high and low price periods.  You can see where the skeptics come from.


Yet notwithstanding all of the preceding, the EIA and by extension Donald Trump and the rest of the US Energy Dominance orthodoxy are true believers in the salvation to be delivered by tight oil – to such an extent that they in fact are committed to exporting these obviously unlimited riches.


Far from a period of energy dominance and independence, a pretty convincing argument can be made that that much of the political swagger over US energy independence seems to be based on hype-fuelled forecasts that were prepared by someone wearing distinctly rose-coloured glasses.


Obviously it could all come true, but depending on which way it breaks, this will have pretty big implications for Canada


So what are the implications for Canada and/or the rest of the world?


Well, let’s get something out of the way first – no matter what the production curve of tight oil is going to be, the world will in fact need all the production growth that US tight oil can muster. And the United States and rest of the world is likely to need all of the oil that Canada can produce as well. Our 3 to 3.5 million barrels per day of exports into the US is secure for the foreseeable future.


Why do I say that? Global demand for oil is projected to grow by about 2 million barrels per day this year, which means that after accounting for global decline rates, somewhere in the neighbourhood of 6 million barrels or more a day needs to be added. Based on the EIA projections, we know that 1 million of that comes from the US. So what about the rest? What about subsequent years?


OPEC-R probably has about 2 million barrels a day of spare capacity that can be brought on-line on short notice (again – OPEC, sorry Saudi Arabia, is the world’s true swing producer). Which still leaves us 3 million barrels a day short, right? How do you make that up?


Well if it’s not coming from shale, It needs to come from long cycle, high reserve and low decline projects, like the North Sea, big finds off the coast of Africa, offshore Brazil, or…


Yup, you guessed it. Canada.


It just so happens that if there is one thing that Canada has going for it in the global energy equation it’s an abundance of long cycle, high reserve, low decline reserves. They are called the oilsands.


And in the context of the above – they are needed. Perhaps quite badly.


Imagine if we had $250 billion a year to spend in the oilsands…


Yes, oilsands projects are massively expensive. But once you build them, they last forever – at least in shale terms. The problem of course always is that you have to spend the money up front, but once it’s complete, it’s complete, you don’t have to do it all over again every year just to keep your head above water and hold off the financiers. It’s the difference between short cycle and long cycle. Don’t believe me, look at the earnings reports for Suncor, CNRL, Husky and Cenovus and compare them to their cash flow eviscerating shale counterparts.


Like all pendulums, there is always momentum to carry you back the other way. Stay strong Canada. We may have lost curling and hockey, but energy is a much longer game. We should be good.


Unless of course there are pipeline issues – ARGH! Why did I go there?


Prices as at February 23, 2018 (February 16, 2018)

  • The price of oil held recovered during the week along with the stock market.
    • Storage posted an increase
    • Production was up marginally
    • The rig count in the US was mixed
  • Despite another large withdrawal, natural gas remained in the doldrums – expect continued volatility…


  • WTI Crude: $61.65 ($59.20)
  • Nymex Gas: $2.564 ($2.584)
  • US/Canadian Dollar: $0.7968 ($ 0.7947)



  • As at February 16, 2018, US crude oil supplies were at 420.5 million barrels, a decrease of 1.6 million barrels from the previous week and 98.2 million barrels below last year.
    • The number of days oil supply in storage was 26.0 behind last year’s 33.2.
    • Production was down for the week by 1,000 barrels a day at 10.270 million barrels per day. Production last year at the same time was 9.001 million barrels per day. The change in production this week came from a marginal decrease in Alaska deliveries and a marginal increase in Lower 48 production.
    • Imports fell from 7.888 million barrels a day to 7.021 compared to 7.286 million barrels per day last year.
    • Exports from the US rose to 2.044 million barrels a day from 1.322 and 1.211 a year ago
    • Canadian exports to the US were 3.219 million barrels a day, down from 3.523
    • Refinery inputs were down during the week at 15.883 million barrels a day
  • As at February 16, 2018, US natural gas in storage was 1.760 billion cubic feet (Bcf), which is 19% lower than the 5-year average and about 26% less than last year’s level, following an implied net withdrawal of 164 Bcf during the report week
    • Overall U.S. natural gas consumption was down during the report week by 14%, influenced by weather
    • Production for the week was flat. Imports from Canada were down 4% compared to the week before. Exports to Mexico fell 3%.
    • LNG exports totalled 11.5 Bcf.
  • As of February 19 the Canadian rig count was 305 – 215 Alberta, 17 BC, 66 Saskatchewan, 6 Manitoba. Rig count for the same period last year was about 270.
  • US Onshore Oil rig count at February 23, 2018 was at 799, up 1 from the week prior.
    • Peak rig count was October 10, 2014 at 1,609
  • Natural gas rigs drilling in the United States was up 2 at 179.
    • Peak rig count before the downturn was November 11, 2014 at 356 (note the actual peak gas rig count was 1,606 on August 29, 2008)
  • Offshore rig count was down 1 at 17
    • Offshore rig count at January 1, 2015 was 55
  • US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 70%/30%



  • The great BC-Alberta wine battle has been called off. Apparently the BC NDP has taken the cap on bitumen shipments through BC off the table so Rachel Notley popped a bottle of Dirty Laundry wine to toast the step down on the impasse.
  • Justin Trudeau was in India, a prime market for Canadian oil shipments. Not sure if he discussed that with anyone but the photos of him and his family sure were pretty
  • Trump Watch: Where to begin? Meh – improvised speech at CPAC, continued indictments and guilty pleas for a bunch of his advisors, finally admitted he was bald… All in all a normal week.
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