On the Sustainability of Cheap Oil

To a Professor of Geology, and as someone with little training in Economics, the feasibility of cheap oil is difficult to fathom. Much of western Canada’s oil is barely economic at $50 USD/bbl: this includes McMurray Formation Ultra-Heavy Oil, Clearwater Formation Heavy Oil in parts of the Cold Lake Field, Mannville Group heavy oil in Saskatchewan and eastern Alberta, and tight oil and gas in Triassic measures of British Columbia. Some of Alberta’s oil is downright expensive, such as Steam Assisted Gravity Drainage (SAGD) projects in McMurray, which can have costs of production near $90/bbl (see note 1).

Two months ago Business Insider published a chart that showed the projected 2020 levels of production along with the mean operating costs of various oil plays. These included Canadian Oil Sands ($74/bbl), North American Shale (Fracing) plays ($62), Ultra Deepwater ($57), various onshore and offshore locales ($43 to $57), and onshore Middle East ($29). The median cost of production within the next 5 years should be close to $55 per barrel, suggesting that low oil prices will, in the future, result in immediate production decreases and prop up the price of oil at least near the $60/bbl range. (see http://www.businessinsider.com/markets-chart-of-the-day-december-29-2014-12)

So, how does oil even fall below production costs? I suppose the answer is that oil production has a lot of momentum. There is no quick response available to producers to check oil production as prices drop. The reasons for this are variable and include a technical necessity for production (e.g. a steam operation is a several-year engagement and once the steam is in the ground, the resource has to be produced before the steam condenses), maintaining shareholder confidence, and feeding downstream operations. It is worth noting that 2 of the fasted growing oil producers over the past 5 years are the United States (47.5%) and Canada (23.1%) (see http://www.businessinsider.com/us-energy-production-boom-charts-2014-12). Not only has North America destabilized oil production, the increases are from highly technical giant oilfields, where production cannot be immediately curtailed.

There is no doubt that producers do feel the pinch. In the Globe and Mail today (https://secure.globeadvisor.com/servlet/ArticleNews/story/gam/20150228/RBCDCOVERNORTHSEAFINAL), EnQuest CEO Amjad Bseisu was quoted “The North Sea was struggling even at $100 [U.S.] oil, I think we’re in a defining moment for the North Sea. We could either see precipitous decline or the industry will have to reinvent itself.”

In Alberta, there is a sense of unease, and although no one is set to jump off the cliff, it is a MUCH quieter place than it was one year ago. Forgotten in all this is that heavy oil (and other unconventional resources) in Alberta are 100-year resources. Our children’s children are likely to be mining and steaming oil from the Cretaceous rocks of Alberta (see note 2). We are in this for the long haul and need to be prepared for ups and downs in oil prices.

This leads us to our discussion. Students of Geoscience, how do YOU think that the price of oil can be better managed? Through production management? Flexible royalty agreements? More carefully managed expansion and development? If oil proce cannot be managed, what other things could be done to weather boom and bust cycles?

Notes:

1. The cost of SAGD production is extremely variable and has ranges between $30 and $95 per barrel. A number of factors influence SAGD optimization, including geological heterogeneity, reservoir thickness and continuity and saturation and viscosity of the heavy oil.

2. Not just the Cretaceous Measures, but unconventional tight resources in the Triassic, Devonian and Mississippian units.

7 thoughts on “On the Sustainability of Cheap Oil”

  1. Fluctuations in oil prices are nothing new, and should be anticipated by any responsible oil company. Price stabilization is more feasible in industries where the resource is produced in excess and controlled by a Monopoly. Large companies capable of embarking upon multi-billion dollar expansions should have more legal responsibility to retain their current employees during down cycles. Oil prices will always fluctuate and the monetary losses associated with bust periods should be felt the heaviest by the people gaining the most during the booms. This type of job security is rare in free market economies like North America, but exist with debatable success in emerging super powers like China. I think boom and bust cycles could be better mitigated by large oil companies if they were required to retain a surplus of funds during booms to keep their ground level workers employed during busts. It’s no secret that there is a great abundance of wealth generated by oil companies, but without stricter controls on the redistribution of this wealth ground level employees will always be subject to to the boom-bust nature of the oil industry.

    1. You know, the Norway model of hoarding money to level the economy works pretty well. They are very good at $$$ redistribution as well. In Alberta, we might be able to hoard money (e.g. Heritage Trust Fund), but redistributing wealth is not likely. Albertan’s are pretty selfish with their dough.

  2. So long as we exist in a free market economy I don’t think the price of oil can be managed. It will always respond to the market forces of supply and demand. What I think needs to change is shareholder perceptions. What shareholders want to see in a bust is job cuts and decreased spending. However I think companies and governments should utilize the increased labor availability and decreased costs during these times to invest in research and infrastructure.

    1. That is interesting! But shareholder enlightenment is pretty unlikely. Shares are owned by emotionless and uncaring mutual fund managers who only love $$$.

  3. One of my main concerns with the oil industry in Canada (Alberta) is the lack of government involvement in this sector. In the simplest sense, I am a strong advocator for higher royalities to oil companies. This was addressed in a previous article about Norway and how its prospering as a country due to the governments involvement in its oil and gas industry (which is perfectly summed up in this article: http://www.desmog.ca/2013/02/28/if-canada-oil-rich-why-are-we-so-debt). On top of its billion dollar surpluses, they have no foreign debt. Yet our governments keep cutting education and healthcare, and face monstrous debts.

    Alluding to the DeSmog article, it states that the royalties that the Alberta government has been collecting have been in the 5-10% range and the Canadian government doesn’t charge a royalty at all.
    Here’s an idea: charge a higher royalty to the major players in the Canadian oil industry. Capitalize on greater tax revenues and thus a stronger safety net when the economy feels the pain.

    How can this help regulate the price of oil? Higher royalties puts less dollars into the pockets of the oil companies and more into our governments. These companies will then be forced to look for cheaper and more efficient ways to produce the oil (lower production costs). The industry will become dependent on innovation and better ways of doing things.

    I guess to summarize what I think is the best way to manage the price of oil or weather the boom and bust cycles, even though I may not know exactly how it can come about, would be to get more government regulation. This will create a more stable net when the prices begin to decline and allow for a much quicker rebound.

    1. I completely agree. The next blog article will be on the Prov Government has been impotent in it’s managing of our resource economy. Very poor leadership and stewardship.

  4. Diversification of industry, its no secret the most diverse economies seem to survive the harder times. Unfortunately, living in Alberta diversification is a tough endeavour when the turnover rate for jobs is so high and the labour shortage causes everyone to be grossly overpaid (its no wonder we are hit so hard during the bust cycles). This makes developing other industry extremely ineffective because they cannot be competitive with other companies based elsewhere when they have to pay their employees so much.
    Sure, hoarding money till everyone is a millionaire sounds like a great idea but long term economic stability is the goal so use the taxes to diversify Alberta’s industry look to emerging fields of science and technology to help us weather the down turn in oil prices. Use the bust part of the cycle to catch up on the labour shortage, re-equilibrate wages and make Alberta competitive for other industries. There is a silver lining to every problem use this bust to diversify and the next bust might not be as bad.

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