Technology is another element comprising the happy talk about the world’s inehxhaustibly abundant oil supplies. As with Saudi Arabia (and other nations’) reserves, the reality is quite different from what is commonly presented. The argument is that oil reserves calculus changed in the last decades as drilling technologies iproved. That, in part, is how the mushrooming oil reserves numbers are justified even in absence of large new oil field discoveries. Unfortunately, experience hasn’t borne out this optimism and the idea that drilling technologies may have turned Saudi Arabia’s 110 billion barrels of proven reserves into 790 billion barrels is unrealistic, to put it politely.

Before fracking, various new drilling technologies, including horizontal line extraction have failed to reverse production declines in conventional oil fields. We can clearly see this in the case of the U.S. production, which has been in decline for over thirty years from the time it peaked in 1970.

The industry encountered similar outcomes elsewhere too, including the North Sea and the Middle East where hyped-up bottle-brush drilling actually appear to have accelerated many oil fields’ production declines.

Along came fracking…

Over the last decade however, a new oil drilling technology raised hopes that the “shale revolution” could offset declines in conventional production of oil and gas. Hydraulic fracturing of shale rock formations or “fracking” started to take off around 2005 in the United States. Technology’s early success finally reversed American production decline, adding well over 4 mb/d to U.S. oil output, [i] and making U.S. the third largest oil producer after Saudi Arabia and Russia. This innovation incited a great deal of optimism and also much hype. Countless reports and articles endorsed fracking and put forward claims that:

• the U.S. would soon become energy independent
• S. oil production would surpass Saudi Arabia’s
• the state of Texas would produce about a third of global oil supply
• the U.S. would become an oil exporting country again.

In some ways, results from fracking surpassed expectations but grounds for optimism have since largely eroded as important limitations of fracking became apparent. To begin with, early assessments of recoverable deposits were overly optimistic. A case in point is the Monterey Shale in California. In 2011, the U.S. EIA claimed it had 13.7 billion barrels of oil resource. Later assessments found that only about 3% of those quantities (some 600 million barrels – about a week’s worth of global demand) are economically recoverable. Likewise, EIA initially estimated that Pennsylvania and New York’s Marcellus Shale had 410 trillion cubic feet of shale gas resources. Subsequently, US Geological Survey determined that only 84 trillion cubic feet of Marcellus Shale Gas were technically recoverable. An even smaller fraction of this is recoverable economically.

Drilling experience further showed that shale oil wells deplete ten times faster than conventional wells [ii] and that maintaining production requires enormous and ongoing capital expenditure to drill new wells. To be commercially viable fracking depends on high oil prices and abundant low-cost capital. Finally, fracking is very controversial from the environmental perspective and its development has encountered increasing pushback from communities that suffer adverse impacts like air and water pollution and earthquakes.

While early industry reports suggested that shale revolution would help push peak oil 40 years or more into the future, this optimism has turned out unwarranted. The International Energy Agency, which in 2012 estimated that U.S. production would keep growing beyond 2030, conceded more recently that U.S. shale oil production would peak around 2020 (significantly, this report [iii] was published in June 2014, pre-dating the oil price collapse that was about to occur). Even the upbeat U.S. Energy Information Administration recently curbed their initial optimism. In its 2014 World Energy Outlook, EIA warned that the U.S. shale boom in fact masked threats to world oil supply and that global energy system is in danger of falling short of expectations. This is a polite way of saying, “we’re in serious trouble and fracking isn’t going to save us.”

This brings us back to the Peak Oil hypothesis. As a consequence of the recent period’s talk about the oil glut and low oil prices, many believed that Peak Oil hypothesis became obsolete. In part 3 of this series we’ll examine again whether this is justified (hint: it is not)…

Alex Krainer is an author and hedge fund manager based in Monaco. Recently he has published the book “Mastering Uncertainty in Commodities Trading“.

Notes:

[i] According to EIA, U.S. shale oil production attained 5.2 mb/d in December 2014!

[ii] According to a comprehensive analysis by David Hughes, oil geo-scientist and 30-year alumnus of the Geological Survey of Canada the average well output for the seven major shale basins declines from 60% to 91% during the first three years of production.

[iii] “World Energy Investment Outlook” – OECD/International Energy Agency, June 2014 – http://www.iea.org/publications/freepublications/publication/WEIO2014.pdf