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American Interest

The New Oil Reality

Crude Economics

walter_russell_mead
walter_russell_mead
Ravenel B. Curry III Distinguished Fellow in Strategy and Statesmanship
Shell's Brent Delta Topside offshore oil drilling rig platform is towed by tug boats along the coastline of Hartlepool, May 2, 2017 (SCOTT HEPPELL/AFP/Getty Images)
Caption
Shell's Brent Delta Topside offshore oil drilling rig platform is towed by tug boats along the coastline of Hartlepool, May 2, 2017 (SCOTT HEPPELL/AFP/Getty Images)

The global oil market is so different today as compared to what it was three years ago that it’s borderline unrecognizable. These changes are being hammered out in a battle between petrostate producers on the one side pushing for a rebalancing of supply and demand by cutting their own output, and a group of upstarts on the other, led by U.S. shale companies, that want to fight to bring the costs of production down permanently from their previously high ($100+ per barrel) levels. No one is more qualified to put this in its proper context than the famed oil historian Daniel Yergin, and in a recent piece for the WSJ he traces what he calls a “cost recalibration” that’s affecting producers not only in America’s shale formations, but outside of the United States as well. He writes for the WSJ:

This cost recalibration is happening everywhere, as a new analysis by IHS Markit shows. Canada’s oil sands have always been among the highest-cost, yet some new projects can produce near $50 a barrel. In Russia, costs have come down more than 50%. Even deep waters offshore can now produce at less than $50. In March the CEO of the Norwegian company Statoil told the CERAWeek conference that owing to a wholesale redesign, a project in the North Sea that had originally required $75 a barrel to be economical now needs just $27 a barrel. […]

As oil producers get back to business all over the world, some of the big cost savings will be given back, which will support rebalancing—so oil prices will rise. But the entire business has been recalibrated to a lower price level. An industry that had become accustomed a few years ago to $100 oil now regards that as an aberration that will not recur absent an international crisis or a major disruption. The lessons about costs since the price collapse are not going to go away. They are too powerful to forget, and too painful.

From Yergin’s expert point of view, the days of $100 oil are behind us, barring some unforeseen catastrophe. That is a major shift not only for the oil market, but also for how we think of energy in the 21st century. While not entirely diminished, fears of scarcity are being replaced by concerns over downstream bottlenecks and how best to handle this newfound abundance of hydrocarbons. These are, as they say, good problems to have.

There’s another thought here: one of the big drivers in the falling costs of oil production is the use of information technology at all levels of the production process—from looking for likely places to drill to the design of rigs and all through the pumping and refining process. These enhanced efficiencies are likely to continue as the full impact of IT is only beginning to be felt.

It’s hard to exaggerate just how striking this is. The oil industry is more than 150 years old, and oil ‘should’ be getting more expensive to find and to pump, not less. The most obvious oil fields should have been found first, and the most promising wells dug long ago. We should now be living in a world of diminishing returns, with more and more money chasing less and less oil. It was this prospect that led so many doom and gloom thinkers in the 20th century to agonize over ideas like “peak oil”.

All that may happen some day, but apparently not soon. The information revolution is so powerful that it can reverse what would otherwise be the natural tendency of the oil market.

But this points to two even bigger stories. One is that the same forces that are making oil and gas so much cheaper and easier to find and extract will also be affecting other commodities. We can expect mining to become more efficient as well, and in fact there’s already evidence of that happening.

And there’s more. One of the big mysteries of the information revolution is the question of productivity. We keep using all this tech that clearly lets us do more with less, but instead of galloping higher, productivity levels have stagnated. What’s going on?

It’s possible that the productivity increases are appearing as lower prices rather than as higher incomes. If the price of oil falls from $100 per barrel to $50 per barrel due to increasingly cheap and efficient methods of production, then everybody in the industry is more productive in terms of barrels of oil per hour of work, but since the oil price has gone down, that productivity increase won’t be captured by statistical methods that calculate productivity in terms of money.

And that is just part of the larger story: that the extraordinarily deep and sustained collapse in the price of information is disguising the enormous increase in the productivity of everyone who works with the defining product of our time. Journalists, to take one (for the staff here at TAI) depressing example, are producing much more “information” than ever before. Armed with the internet, the TAI writers can cover a range of subjects with a wealth of detail on a daily basis in a way that a much larger staff simply could not have matched 20 years ago.

On the other hand, the very explosion in the productivity of writers generally has meant a rapid collapse in advertising revenue. Measured in units of information processed and produced, the TAI staff is much more productive than past generations of journalists; but the very abundance of supply caused by the productivity of the sector leads to a crash in values that, again, makes the productivity revolution invisible to methods of measurement that look solely to revenue per work hour.

At the same time, the collapse in the cost of information helps disguise the enormous increase in living standards for most people. Anybody connected to the internet and using a smartphone today devours quantities of information today that medium sized companies could not produce in the 1970s. The African villager with a solar powered smartphone has more access to more information than Louis XIV in the halls of Versailles.

But since the cost of this product is falling so quickly, the rise in living standards we are living through isn’t measured.

Just as the industrial revolution forced economists and businesses to find new ways to measure output, the information revolution is likely to lead to revolutions in the way we measure economic performance in the 21st century.