By John Richardson
TECHNOLOGY doesn’t stand still. That’s the whole point about technology as any oil, gas or chemicals engineer will tell you.
The above chart is a fantastic example of this. It shows how the efficiency of US oil rigs, thanks to improvements in the fracking process, has improved by leaps and bounds from 2012 onwards.
The chart also tells you something else equally important: US inventories have risen to ever-greater record highs as fracking techniques have improved.
The good news is that many analysts predicted improvements in fracking technology, and thus have assumed lower production costs. But the bad news starts with the fact that most analysts have hugely underestimated the speed of innovation.
The even bleaker news is a widespread misunderstanding of how businesses have always worked in times of financial distress, which is just one of the reasons for the build-up in inventories:
- Why shut down altogether and have no chance of paying anything back on your debt? This just doesn’t make sense – and has never been how the corporate world has worked.
- Any company in any sector will instead continue to run their assets as its lack of cash-flow rather than debt that often kills companies.
- And, anyway, banks can always be persuaded to write off debt. They often have little choice, as if they foreclosed on a company they might not get even one cent back.
Combine this with the giant leaps in fracking technology and you have some of the important context you need to understand today’s chart.
What happens next? Production costs will keep coming down, and assets on the ground that might eventually go bankrupt will remain exactly that – assets on the ground. A private equity company might, say, come a long, buy up a shale oil asset debt free and then run it as hard as possible, as the private equity company will only have to cover variable costs.
There is also my long-standing argument that one of the few genuine bright spots in the US economy is shale oil – and, of course, shale gas as well. In a deflationary world, politicians on both sides of the US divide will be keen to provide every incentive possible that encourages greater oil and gas production. A good example of this was the recent decision to lift the ban on US oil exports.
Yes, I know, I am repeating the arguments I have made before – albeit backed up some powerful and very important new data. But I have to keep going – I have to keep plugging away at the harmful consensus out there – as I want your chemicals business to prosper.
The danger right now is that people will be knocking on your office door, eager to tell you that today’s recovery in oil prices undermines the wider arguments as to why we are in world of abundant and cheaper oil.
I am not going to say, “Don’t listen to them” – that would be wrong – as everyone is entitled to a hearing. What I would instead advise is how to frame one crucial question that you ask of these people. Rather than asking them “Why should oil prices fall to their long-term average price of $26/bbl?” you must pose the question in this way, “Why shouldn’t oil prices return to $26/bbl?”
Only then will you start to make some real progress.