Shale Oil: Another Layer of US Power


Mauldin Economics [Outside the Box] – Shale Oil: Another Layer of US Power, June 28, 2017

Energy, particularly oil, is a source of geopolitical power. Every country needs it, but only some countries have the resource to procure it themselves. Some countries have enough of it that they can profit its export, and others have so much that they rely on it almost exclusively to fuel their economies.

When prices bottomed out a few years ago, most oil producers, including Saudi Arabia and Russia, were expected to cut production to normalize prices. Important reason supply is so high, despite recent efforts by OPEC and Russia to cut production, is that US has exceeded expectations on how much oil it could bring to market. With the continued use of hydraulic fracturing and other related technologies, the US is now believed to have more recoverable oil reserves than any other country in the world, and it is reaping the benefits of its newfound status.


  • Saudi Arabia and Russia are geopolitically important countries – what happens to Saudi affects the regional balance of the Middle East and what happens to Russia affects Europe, Asia, and beyond
    • Their importance is due in no small part to their vast energy reserves, which are their primary source of government revenue
  • In Saudi Arabia, oil revenue has enabled the government to create patronage networks public and private alike; it has also enabled Riyadh to be the de facto leader of the Middle East
    • Without oil, government could not fund its Sunni Arab proxy groups in the battle for regional control, finance the war in Yemen or even maintain social stability
  • Russia is considering cutting defense spending in the coming years and is struggling to finance state pensions; now that Reserve Fund is being depleted, Moscow will have to switch over to its National Wealth Fund which has over $70 billion but is much more difficult to tap into
  • OPEC, which Saudi essentially leads, has so much recoverable oil that it has been able to more or less control oil prices by adjusting production levels, sometimes in concert with Russia
    • By some estimates, the US has surpassed Saudi Arabia in recoverable oil reserves as advancements in hydraulic fracturing and horizontal drilling have enabled producers to access areas previously not thought possible

Peculiar Economics

  • Drilling for shale costs less per project than, say, deep-water drilling. There are two general types of costs: capital costs and operating costs
  • Total well cost – entire amount of investment required to set up a new well, including land, permits, drilling and completion – varies by location but runs consistently in the millions of dollars
  • Once the oil starts to flow, operating costs tend to vary – gathering, processing, and transportation can range from $2.25 to $5 per barrel; water disposal can range from $1 to $8/bbl and other G&A range from $1-4/bbl
  • Since capital and operating costs are so varied, there is no single breakeven price for shale oil – according to Wood Mackenzie, it is estimated that 60% of all crude reserves that are economically viable at $60/bbl or less are located in US shale reserves
  • Industry would continue to innovate even if, all things equal, oil prices increased. In fact, wells have been productive independently of price trends. Higher prices will keep the drillers drilling until oversupply drives prices down again

No Reason Not To

  • In Russia and Saudi Arabia, it’s still much cheaper to drill for conventional oil than for shale oil – each can produce for about $10-15
  • With oil priced at $50, the government in Riyadh will make more money off a single barrel than a shale oil driller will for the foreseeable future – this explains why OPEC could afford to maintain high levels of production even when prices fell so dramatically from 2014 to 2016
    • Its members and Russia thought that if they kept prices low and captured market share, they could outlast US shale producers who could no longer afford to operate (in theory)
  • OPEC didn’t expect shale oil drillers to lower their costs as much as they did nor did it anticipate how quickly they could complete unfinished projects
  • Moreover, driller in US doesn’t need to be more profitable than Saudi – driller just needs to fetch a sufficient return on invested capital
  • Number of drilled but incomplete wells has grown over the past months – when oil prices reach the upper end of the $40-$60 per barrel range, these wells begin to produce, bringing even more oil onto the market
  • Saudi and Russia can produce oil more cheaply than their US counterparts but rampant government expenditures make their fiscal break-even point – the price at which their budget is not running a deficit – much higher
    • IMF estimates that oil will need to cost $78-80/bbl in the next two years for the government in Riyadh to break even on its fiscal budget
    • Russia’s breakeven point is lower at $68/bbl but it’s still higher than current prices
  • The two countries will have to run budget deficits – which deplete their fiscal reserves – to continue the social spending programs that earn them the support of their people
    • For Russia, that means cutting state pension plans on which more than 90% of its citizens depend for their retirement
    • For Saudi Arabia, that means cutting benefits for state employees who have grown accustomed to a comfortable lifestyle
  • US shale producers, are now profitable at levels below the fiscal breakeven points of Russia and Saudi Arabia – they have no reason not to drill more
    • Even if prices climb high enough for Riyadh and Moscow to break even, it is unlikely that they will stay there for long, since high prices encourage shale producers to drill more
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  • US is uniquely positioned to be energy independent – or at least less dependent on oil imports – something it has wanted to be for decades
  • Contemporary US power is built on two layers: its military might and its relative independence on exports at a time of stagnant global demand. Energy independence would give it a third layer, making it only more power
  • Geopolitics is rarely a zero-sum game – but in the case of shale oil, what’s good for the US is bad for its rivals
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