Crude: All fracked up

Daily Energy Market Analysis

Oil prices are responding positively to an extension of the current OPEC/Non-OPEC production deal, especially because Nigeria and Libya agreed to cap production, but a monthly report by the Energy Information Administration (EIA) on U.S. production rising over 3% to 9.48 million barrels a day seemed to put a bit of a wet blanket on the markets' enthusiasm. Not to mention a million barrels of hedged shale oil output. Yet, a new study by MIT suggests that the EIA may be vastly overstating the potential for U.S. shale oil and if that is true, the potential for a major oil price spike in the coming years is a real danger. The report from MIT says that shale oil output may come short of EIA projections by a whopping 10% in the next 3 years. In other words, the data on shale may be all fracked up.

As reported by Bloomberg, researchers at MIT have uncovered one potentially game-changing detail: a flaw in the Energy Department’s official forecast, which may vastly overstate oil and gas production in the years to come. The culprit, they say, lies in the Energy Information Administration’s premise that better technology has been behind nearly all the recent output gains, and will continue to boost production for the foreseeable future.

Yet, the study says according to Bloomberg “That’s not quite right”. Instead, the research suggests increases have been largely due to something more mundane: low energy prices, which led drillers to focus on sweet spots where oil and gas are easiest to extract”.

“The EIA is assuming that productivity of individual wells will continue to rise because of improvements in technology,” said Justin B. Montgomery, a researcher at the Massachusetts Institute of Technology, and one of the study’s authors. “This compounds year after year, like interest, so the further out in the future the wells are drilled, the more that they are being overestimated.”

Extrapolating from field studies Montgomery and his colleague Francis O’Sullivan conducted in North Dakota’s Bakken shale deposit, the research suggests that total U.S. oil and natural-gas production from new wells could undershoot the EIA estimate by more than 10 % in 2020. Things would get progressively worse each year after that as wells in various sweet spots are exhausted and technology fails to close the gap. “The same forecasting methods are used in other plays in the U.S., and the same dynamic is likely to be present,” Montgomery added.

Margaret Coleman, the EIA’s leader of oil, gas and biofuels exploration and production analysis, said in an email “the study raises valid points” and the administration is looking at ways to give its estimates a tighter focus. She added that many shale fields lack the detailed well data that informed the MIT study, which means EIA forecasters must use known geologic information and assumptions about prices and technology to come up with estimates, as reported by Bloomberg.

This study then should shake up both long-term and short-term oil prices and production forecasts. This forecast, along with a crash in prices, is one reason we have seen a major drop in investments in more traditional projects because they thought that shale would make those projects unprofitable. Even with yesterday’s impressive mostly production number from EIA we are still a million barrels below where the many shale optimists said we would be. So if you have to lower future shale output over the next few years by 10%, that is a big miss and may have major ramifications for the global economy. With global economies moving at breakneck speed, demand growth is going to overtake our ability to catch up.

As for natural gas, we hit the EIA number of -33bcf right on the head. Still, the market took that as a bit bearish. That puts total storage number at 3.693 Tcf. That compares to the -43 Bcf change last year and -47 Bcf change for the five-year average. Still, overall supply is 7.7% below a year ago and 2.8% below the five- year average. If it ever gets cold, you better watch out, you better not cry, you better get long, I'm telling you why to wait it does have to get cold first.   

About the Author

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor.