How Technology Drove The US Shale Oil Industry And What It Means to Russia

Art Franczek, President, American Institute of Business and Economics in Moscow

 Nothing is more central to the Russian economy as the global price of oil. A recent economic report indicates that a 1 dollar decline in the price of oil entails an annual loss to the Russian budget of about US$2 billion, so when oil drops from, for example, from US$43 to US$31 per barrel, the budget has lost about US$24 billion and the dollar exchange rate goes up from US$65 to US$77, demonstrating the link between the price of oil and the rouble. Macroeconomic factors can influence the price of oil, for example when the IMF lowered the world GDP forecast by 3% for 2015 the price of oil declined. When China lowered its 2015 GDP from 8% to 6.8% this also had a negative impact on the price of oil, and the 2016 decline in the price of oil was attributed to economic uncertainty in China. Between 2003 and 2013 China accounted for 45% of the increase in world oil demand. Supply and demand are the main drivers of the price of oil. World oil demand in 2015 was 94.6 million barrels a day while supply was 96.9 million barrels causing a downward pressure on the price of oil. 3 billion barrels of worldwide oil inventory drives the price downward as it contributes to the glut in oil. The recent increase in US interest rates by the US Federal Reserve Bank created some downward pressure on the price of oil as the dollar strengthened.

The most unpredictable driver of the price of oil is geopolitical events. In the past 60 years oil spiked during the 1956 Suez crisis, the 1973 Yom Kipper war, the 1979 Iranian Revolution and most recently the war between Saudi Arabia and Yemen in April of 2015 caused the price of oil to increase to US$65 a barrel from US$50. During the worldwide financial market meltdown in 2008, oil plummeted from US$147 to US$35 per barrel. The effect on Russia was devastating, with a decline in GDP of 8%.

After the first global oil shock during the 1970s, nations were forced to consider what a future with dwindling fossil fuel supplies might look like. One response was to look for new types of fossil fuel reserves and develop ways to reach them. Over forty years later, these efforts are finally beginning to pay off. Horizontal drilling and hydraulic fracturing, the technologies for reaching ‘unconventional’ reserves such as natural gas and light tight oil (LTO) trapped in rock formations (often shale) are now widely being used. These extraction techniques have the ability to unlock both newly discovered reserves and previously known deposits that could not be economically extracted using conventional methods.

Unconventional oil and gas reserves are defined as reserves that cannot be extracted by conventional drilling methods. In these reserves, oil or gas is trapped in natural fractures in rock or absorbed by organic material. Besides shale gas and LTO, unconventional fossil fuel deposits include coalbed methane, tight sandstone and methane clathrates.

Declining natural gas reserves during the 1970s prompted the United States to fund research into the extraction of shale gas, leading to many technological advances including microseismic imaging. The US government encouraged drilling for shale gas through tax credits, research dissemination, and industry support. In 1991, it supported the first horizontal drilling project, and in 1998, the first commercial shale fracture in the Barnett Shale basin in the state of Texas. The first combination of hydraulic fracturing and horizontal drilling followed in the Barnett basin in 2005.

The use of the latest drilling technologies generated productivity growth, as measured by initial production per rig of over 30% per year between 2007 and 2014. The ‘walking rig’ or pad drilling is one technological advance that has contributed greatly to gains in rig productivity. Rather than a single well from a well-pad, a walking rig can move around the pad, drilling multiple wells (sometimes dozens). Since 2006, the use of pad drilling has grown dramatically from a few percent to over 50 percent of new wells, with the potential to rise higher. This partially explains the disparity between the recent closing of 60 percent of rigs and the decline in production of only 3%. The older less efficient rigs have been closed while the newer pad drilling rigs with multiple wells have remained active. Another innovation used extensively is 3D seismology that supports hydraulic fracturing by giving developers a better understanding of the geology of the reservoir and how best to stimulate it.

The single biggest advancement now coming to the shale industry is the use of big data for radically better asset optimisation and operations. In every sector of the US economy, the availability and collection of data from machines, services and business operations is growing at an astonishing rate. Still, a large amount of data remains disparate and disordered. The use of big-data analytics offers nearly all industries the potential for unprecedented insight, efficiency and economic value. Big-data analytics can already optimise the surface mapping of the best drilling locations; indicate how and where to steer the drill bit; determine, section by section, the best way to stimulate the shale; and ensure precise truck and rail operations. Mobile computing using app-centric analytics can increase uptime, reduce maintenance, improve workforce productivity, reduce errors and rework, and enable low-cost compliance. Halliburton reports that its analytic tools have achieved a 40 percent reduction in the cost of delivering a barrel of oil. Baker Hughes says that analytics have helped it double output in older wells. Schlumberger announced a 50% gain in productivity thanks to the use of analytics. Conoco Phillips combined the latest sensors (which extract data by the minute rather than daily), wireless networks and big-data analytics to boost output by 30% in existing wells.

A key point is that fracking is more like a standardised, repeated manufacturing process, rather than the one-off, large scale engineering projects that characterise many conventional oil projects. While conventional projects might take 7 years to produce oil, tight oil projects can achieve production in 2 or 3 months. The US has become the world leader in shale oil production because it has a long history of wildcat oil entrepreneurs and capital markets in addition to a legal system that allows any landowner to sell their mineral rights without government approval. Although Russia and China have huge shale deposits, they lack a supportive environment to encourage the development of their shale resources.

The US has become the world leader in shale oil production because it has a long history of wildcat oil entrepreneurs and capital markets in addition to a legal system that allows any landowner to sell their mineral rights without government approval.

Although US shale production accounts for less than 5% of the global market, the rapid growth in US shale oil was the key factor driving the collapse in the price of oil in 2014. Since 2008, the US has increased its shale production to 4.5 million barrels per day, and this oil was previously imported from Saudi Arabia, Nigeria and other oil exporters. In November of 2014 OPEC led by Saudi Arabia maintained a production level of 30m b/d, a strategy primarily aimed at maintaining its market share by driving US shale producers out of the market while also hurting Russia and Iran.

For the time being OPEC’s strategy seems to be working, as US oil production declined by around 1 million b/d in 2016 from its 2015 peak of 9.6 million b/d. Many high cost shale producers are going bankrupt and ‘zombies’ (companies that can afford only to pay interest and other expenses and cannot afford to drill for oil) are becoming more common. This strategy has some risks for Saudi Arabia. For example, if the price of oil remains at US$ 40 a barrel it has to use up US$ 10 billion a month from its currency reserves to maintain current budget spending levels. This is important because a significant portion of its budget goes to social spending that is needed to maintain political stability. Although the US shale companies have significantly cut production, they can quickly re-start production when the price of oil recovers in 2017 as Daniel Yergin and other analysts are forecasting.

As long as Russia is dependent on oil for 70% of its exports, Russia’s economy will be intrinsically linked to the fluctuation of the global price of oil. The main driver of the price of oil is the Saudi/US shale conflict that was a direct result of the advancement of shale extraction technologies employed in the United States. The current crisis has created an opportunity for Russia to provide tax and financial incentives to encourage technological innovations such as big data analytics. These innovations can be applied not only to the development of Russia’s massive shale reserves but also to the enhancement of productivity in other areas such as logistics and the localisation of manufacturing. An improvement in these areas will help Russia to be competitive in a dynamic global environment.

Art Franczek, 2017