Relentless shale …

However, there is one area I want to highlight today and that is our progress on capital efficiency. You will recall in 2016, we outlined organic capital expenditure guidance of $13-14 billion per year out to 2021. In February of this year we said 2018 would be $12-13 billion. Today, I feel confident we will be at the lower end of that range.

This progress has created the space for us to invest in this opportunity in the Lower 48, while continuing to hold our organic capital spend at $13-14 billion per year. This is a story of improving capital productivity.

Bernard Looney, CEO Upstream, BP

It was a big week in the shale world last week with BHP selling their shale assets to BP. BP has stated it will divest itself of $5-6bn of assets to help fund this move. What will be really interesting is where the divestments will take place? I expect a further sell off of offshore assets as the overall BP portfolio is weighted further to these sorts of high productivity potential assets. BP made the following comment that they had:

[i]ncreas[ed] offshore top quartile wells from around one-third in 2013 to almost two-thirds this year.

Expect ones outside that category to be classed as “non advantaged” and be up for sale.

The same week the IEA published the graph above showing that for the first time Free Cash Flow from shale will be positive for the first time (see graph above). I never got that worried about this metric because US capital markets have a history of funding loss making companies with high capital needs (Uber being an extreme example) provided there is some sort of rationale and pathway to profitability. But this will only help the “shale narrative” attract further funding.

It is hard to overstate the macro effects of the seismic change in the oil industry but also the world economy, the IMF recently calculated that the shale revolution cut the US current account deficit by 1.4% and on a price weighted basis by 1.75%:

IMG_0711.JPG

The shale revolution isn’t just higher prices for the end product: it is a real story of increasing productivity. There is an outstanding story about this on Reuters (appropriately tagged under “Technology” read the whole thing):

Today, BP operates more than 1,000 shale wells that produce mostly natural gas in the Haynesville basin, which straddles eastern Texas, Arkansas and Louisiana.

It has used the data from its automated wells to create a streamlined system that farms out maintenance to a fleet of lower-cost contractors. The firm now orders up repairs much in the same way a homeowner uses a mobile app to hire a maintenance person or a passenger summons an Uber for a ride.

BP puts repair work out for bid to pre-approved contractors, who then compete for jobs. Each contractor is rated after completing the work, and those with high rankings have a better chance of getting hired again.

Welcome to the future of offshore. This focus on process, a hallmark of mass production, has translated into dramatically lower costs:

BP Productivity lower 48.png

This is a genuine productivity improvement and not the result of someone selling a rig or vessel below its true economic cost. At some point the offshore industry is going to have to accept the scale of this industry on its ability to price at the margin and get the utilisation required to make a large number of assets operative.

The shale industry at the moment is one of ever increasing process of capital deepening. This productivity improvement is happening at a time when the rig companies are reporting record rates and utilisation for Super Spec land rigs and associated services. The shale supply chain are managing to increase CapEx and get price inflation while helping their customers lower costs and increase productivity. Yes, there are constraints for take-out in the Permian at the moment, but they will clear in 12-18 months, well before a major offshore project can be completed and a timeframe with enough visibility to make Boards think twice before sanctioning a raft of mega projects.

As these new investments bear fruit, and the capital base has deepened, you can expect to see unit costs lowered even more, particularly where capital replaced labour (i.e. pipeline distribution versus trucking). This is a virtuous cycle. If you don’t think this can happen in commodity industries over the long run look at food production and prices which have followed a similar process of capital deepening and productivity despite demand increasing massively:

IMG_0708.JPG

(I am not predicting the end of cyclicality in oil prices merely highlighting that it is not a given that they must increase, particularly in the short-run).

I think this points to the fact that a “recovery” in offshore will be a far more muted and affair than in previous cycles. If anything oil companies are smart enough to realise that competiton is the most time tested method of ensuring competitive prices and the competition for capital allocation between onshore and offshore works to their advantage. It is very hard to see price inflation creep into the supply chain when overcapacity exists in offshore and productivity improvements so achievable in onshore.

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