Conventional wisdom underestimated the Permian Basin and Big Oil

Conventional wisdom used to be that as the major integrated oil companies acquired smaller independents, production growth in the Permian Basin would slow. The same wisdom held that regardless which companies were operating in the Permian and other shale plays, domestic U.S. production would peak in the mid-2020s and then begin to decline.

It’s time to reassess those assumptions.

Bullish projections this week from Exxon Mobil and Chevron on their separate operations in the Permian are rewriting the conventional wisdom about that basins potential.

If what the major integrated companies are saying about the Permian is true, it presents serious questions for global oil markets, particularly for the cartel otherwise known as OPEC. It’s also represents a challenge to future projects in the deep-water offshore, oil sands, the Arctic and other higher-cost basins.

Let’s start with OPEC where the impact could be most damaging. The cartel expects shale growth to “slow significantly” after 2023, causing U.S. output to peak at 14.3 million barrels a day by 2028. OPEC then expects U.S. production to fall to an average of 12.1 million barrels a day by 2040.

That’s a convenient outlook if you’re a member of OPEC. In recent years, U.S. shale has single-handedly been meeting increases in global oil demand, forcing the Saudi-led cartel to curtail production to avoid a price collapse. No doubt the members of OPEC, along with co-conspirator Russia, would prefer to see U.S. production reversed sooner rather than later.

The cartel is not alone in thinking that the dominance of American shale must have an expiration date. The International Energy Agency, the consumer watchdog for developed countries, also sees the market the same way. The IEA expects shale production to plateau in the mid-2020s, ultimately falling by 1.5 million barrels a day in the 2030s due to resource constraints.

After 2025, the “baton gradually passes to OPEC to meet continued – albeit slowing – growth in global oil demand,” according to the most recent IEA long-term outlook.

If this scenario doesn’t materialize, OPEC will have some tough decisions to make, including whether to challenge shale to another price war. The cartel lost the last time it took on shale in 2014. And it started subsidizing U.S. production in late 2016 when it agreed to the production curbs that remain in place today.

Unless OPEC and Russia are prepared to live with the supply cut arrangement indefinitely, the cartel may need to throw down the gauntlet… again. That’s because the data presented this week by Exxon and Chevron, now two of the most significant players in the Permian, paints an extremely rosy picture for the future of the basin, even under lower oil price scenarios.

The two majors are expected to produce close to 2 million barrels of oil equivalent a day combined from the Permian by the mid-2020s, effectively tripling their 2018 output. Chevron plans to increase production to 600,000 barrels a day by 2020, reaching 900,000 barrels a day by 2023. Exxon, meanwhile, expects its Permian production to hit 1 million barrels a day by 2024.

Perhaps more importantly, the Permian has proven to be among the most profitable assets in the companies’ global portfolios.

Exxon analysts say the company’s wells in the Permian are capable of delivering returns of more than 10 percent at an oil price as low as $35 a barrel.

Profit margins are even higher at Chevron, which owns most of its land outright and doesn’t have to pay landowners for drilling rights. “Shale returns are the highest in our portfolio,” said Chevron CEO Mike Wirth, adding they are “north of 30 percent at low oil prices.”
The major oil companies were slow to realize the potential of the shale wells in the Permian Basin but Chevron and Exxon are all in now.  If anything the OPEC predatory pricing scheme which attempted to kill the shale development made it stronger by forcing the producers to become significantly more productive.  Now their cost of production is in many cases lower than that of OPEC.  If US refineries convert their operations to handle the light crude coming out of the shale wells, the US will have no need to import oil from OPEC countries.


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