The New Oil Surplus

Commercials on the radio and TV have a remarkable message these days in the United States. America has entered a new era of energy abundance thanks to hard-working men and women. The country is the new energy superpower. Usually an American’s self-image needs to be discounted, but this time everything is true. The country is the largest gas producer in the world and is on course to bring more crude oil out of the ground than any other country in the world. Prices have plunged for a good six months.

Such a development has never been seen before. The world had just gotten used to the idea of putting fossil fuels behind it since they would run out and also seemed more harmful to the climate and the environment than originally thought. The surprising new surplus has a simple explanation: A strongly expanding supply met unexpectedly low demand.

Industrialized countries have decoupled energy consumption from economic growth. Such countries are more energy efficient. Up-and-coming China ordered less crude oil than expected because the economy is growing much more slowly, but the deciding factor was the large group of American consumers who bravely tread the path to self-sufficiency. Thus, the world’s producers lose their best customer.

Large Investments Are Now Paying Off

Fracking is the keyword. This is an old delivery method that has been practiced for nearly 50 years, incidentally, also in Germany. American oil tycoons have associated the technique of horizontal drilling with it. At the same time, the method for exploring deposits has improved. This is the technical explanation for the comeback of America, “Land of Oil.”

But more important than technique is capital. Oil companies have been in position to invest heavily in technology and exploration for years, given high oil prices. Producers have invested unimaginably large sums. These investments have borne fruit.

This explains not only the current rise of oil producers in America, but the record production in Canada and several deep water locations as well. Capital and technology develop new sources and extend the life of old deposits. High oil prices were therefore not only a prerequisite for a huge boost to investment, but they also brought old, producing wells to the point of break-even profit.

That applies to tar sands in Canada, various Siberian projects, and, of course, for American deposits. However, in light of the current decline in prices, the question is not whether the boom is over or if the boom has just really started. Have America’s hard-working frackers shot themselves in the foot?

There is evidence for this. There are cutbacks in investment budgets throughout oil companies. First, producers become insolvent, and industry suppliers have fired thousands of workers. Industry sectors put less money into oil production today and court a new business cycle, which could lead to new shortages and record prices in a few years.

However, fracking has already changed the old rules of the oil business. In order to develop classic conventional reserves, producers invested heavily in anticipation of a long phase of exploitation. Years passed until the investments materialized. If the same industry participants invested in bringing newly discovered deposits to market, prices could fall. This is the explanation for rises and falls in the oil market for many years.

Fracking has left the business breathless. Many new oil producers can react much faster. They are already accustomed to constant redrilling due to the special nature of the delivery method to maintain production levels. This has two important effects: One is that frackers efficiently learn to drill much faster because they have to drill all the time; therefore, they manage to lower production costs per barrel of crude oil much faster than expected.

Experts still claimed in the fall that oil priced below $70 per barrel would ruin frackers. Then they said that $60 was the fatal drawing line. Lately, voices say that many frackers could possibly survive with an oil price of $40 per barrel.

The second effect is equally strong: Once interrupted, production can now be re-activated much faster than it could in the old world of oil. Even if the price should sink so low that Americans stop production to minimize losses, they are right back to where the oil market promises them higher prices. Fracking is just one method among many to gain access to valuable raw materials, after all. It has forever changed the oil business’s way of thinking.