The case against shale…

FT Commodities Note has a opinion today by Robert McNally today making the case against shale acting as a swing producer in the oil market. The argument goes against everything I think and have written about here, and is contrary to the argument Spencer Dale makes.

I don’t agree with many points. For example:

US shale production is comprised of many dozens of highly idiosyncratic public and private companies, each competing with each other to maximise reserves and production. Shale’s shorter cycle ebb and flow can stabilise prices, but only coincidentally and depending on prevailing, broader market fundamentals…
True swing production is a very different animal: swing producers comprise a relatively small number of government-sanctioned entities controlling the bulk of low-cost wells that collude under a policy mandate to stabilise oil prices. Historical examples include the Texas Railroad Commission and other oil states, Seven Sisters, and Opec. Swing producers subordinate profit maximisation to price stability and bear the costs of holding idle or spare production capacity to contend with disruptions and unexpected demand surges.

McNally’s definition of swing production is an organised price cap not swing production based on excess capacity/capital that would not be profitable in its own right.. It is a cartel to cap prices irrespective of profit. Current shale producers seek to make a profit as the price of oil rises. The shale industry has shown it can be a swing producer, and do so with a sole profit maximisation, because it has a different economic model where latent capacity can be maintained without the expense that traditionally large projects entailed? The tradeoff is a much higher operating cost instead of a higher initial capital cost.

I think McNally misses the whole point: that an entire industry has been formed out of market demand for swing producers, and that they don’t require a subsidy to compete. This industry seems to be relatively adept at adding to rig supply or reducing it as prices change (as the above grpahic makes clear). We have heard a large number of reasons why shale will fail: :”Permania” land values, US capital markets shut down, technology limits etc., and shale is still here and going strong with E&P majors committing vast amounts of CapEx to it.

McNally makes the case that shale is too small and slow to fully plug the gap left by conventional projects. I think he misses the point of the declining importance of reserves, and also the unwillingness of future US administrations to give up a degree of energy security the country has developed. However, McNally is a respected thinker on energy so if you want the bear case for shale, and the bull case for high oil prices, read it.


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