The Real Cause Of Low Oil Prices: Interview With Arthur Berman

By Tyler Durden
Created 01/07/2015 - 19:45
With all the conspiracy theories surrounding OPECs November decision not cut
production, is it really not just a case of simple economics? The U.S. shale boom has
seen huge hype but the numbers speak for themselves and such overflowing
optimism may have been unwarranted. When discussing harsh truths in energy,
no sector is in greater need of a reality check than renewable energy.
In a third exclusive interview with James Stafford of Oilprice.com [24], energy expert
Arthur Berman explores:
How

the oil price situation came about and what was really behind OPECs
decision
What the future really holds in store for U.S. shale
Why the U.S. oil exports debate is nonsensical for many reasons
What lessons can be learnt from the U.S. shale boom
Why technology doesnt have as much of an influence on oil prices as you might
think
How the global energy mix is likely to change but not in the way many might have
hoped
OP: The Current Oil Situation - What is your assessment?
Arthur Berman: The current situation with oil price is really very simple. Demand is
down because of a high price for too long. Supply is up because of U.S. shale oil
and the return of Libyas production. Decreased demand and increased supply
equals low price.
As far as Saudi Arabia and its motives, that is very simple also. The Saudis are good at
money and arithmetic. Faced with the painful choice of losing money maintaining
current production at $60/barrel or taking 2 million barrels per day off the market and
losing much more moneyits an easy choice: take the path that is less painful. If there
are secondary reasons like hurting U.S. tight oil producers or hurting Iran and Russia,
thats great, but its really just about the money.
Saudi Arabia met with Russia before the November OPEC meeting and proposed that if
Russia cut production, Saudi Arabia would also cut and get Kuwait and the Emirates at
least to cut with it. Russia said, No, so Saudi Arabia said, Fine, maybe you will
change your mind in six months. I think that Russia and maybe Iran, Venezuela,
Nigeria and Angola will change their minds by the next OPEC meeting in June.
Weve seen several announcements by U.S. companies that they will spend less money
drilling tight oil in the Bakken and Eagle Ford Shale Plays and in the Permian Basin in

2015. Thats great but it will take a while before we see decreased production. In fact, it
is more likely that production will increase before it decreases. Thats because it takes
time to finish the drilling thats started, do less drilling in 2015 and finally see a drop in
production. Eventually though, U.S. tight oil production will decrease. About that
timeperhaps near the end of 2015world oil prices will recover somewhat due
to OPEC and Russian cuts after June and increased demand because of lower oil
price. Then, U.S. companies will drill more in 2016.
OP: How do you see the shale landscape changing in the U.S. given the current oil
price slump?
Arthur Berman: Weve read a lot of silly articles since oil prices started falling
about how U.S. shale plays can break-even at whatever the latest, lowest price of
oil happens to be. Doesnt anyone realize that the investment banks that do the
research behind these articles have a vested interest in making people believe
that the companies theyve put billions of dollars into wont go broke because
prices have fallen? This is total propaganda.
Weve done real work to determine the EUR (estimated ultimate recovery) of all
the wells in the core of the Bakken Shale play, for example. Its about 450,000
barrels of oil equivalent per well counting gas. When we take the costs and
realized oil and gas prices that the companies involved provide to the Securities
and Exchange Commission in their 10-Qs, we get a break-even WTI price of $8085/barrel. Bakken economics are at least as good or better than the Eagle Ford
and Permian so this is a fairly representative price range for break-even oil
prices.
But smart people dont invest in things that break-even. I mean, why should I take a risk
to make no money on an energy company when I can invest in a variable annuity or a
REIT that has almost no risk that will pay me a reasonable margin?
Oil prices need to be around $90 to attract investment capital. So, are companies OK at
current oil prices? Hell no! They are dying at these prices. Thats the truth based on real
data. The crap that we read that companies are fine at $60/barrel is just that. They get
to those prices by excluding important costs like everything except drilling and
completion. Why does anyone believe this stuff?
If you somehow dont believe or understand EURs and 10-Qs, just get on Google
Finance and look at third quarter financial data for the companies that say they are
doing fine at low oil prices.
Continental Resources is the biggest player in the Bakken. Their free cash flowcash
from operating activities minus capital expenditureswas -$1.1 billion in the thirdquarter of 2014. That means that they spent more than $1 billion more than they made.
Their debt was 120% of equity. That means that if they sold everything they own, they
couldnt pay off all their debt. That was at $93 oil prices.

And they say that they will be fine at $60 oil prices? Are you kidding? People
need to wake up and click on Google Finance to see that I am right. Capital costs,
by the way, dont begin to reflect all of their costs like overhead, debt service,
taxes, or operating costs so the true situation is really a lot worse.
So, how do I see the shale landscape changing in the U.S. given the current oil price
slump? It was pretty awful before the price slump so it can only get worse. The real
question is when will people stop giving these companies money? When the drilling
slows down and production dropswhich wont happen until at least mid-2016we will
see the truth about the U.S. shale plays. They only work at high oil prices. Period.
OP: What, if any, effect will low oil prices have on the US oil exports debate?
Arthur Berman: The debate about U.S. oil exports is silly. We produce about 8.5 million
barrels of crude oil per day. We import about 6.5 million barrels of crude oil per day
although we have been importing less every year. That starts to change in 2015 and
after 2018 our imports will start to rise again according to EIA. The same thing is true
about domestic production. In 2014, we will see the greatest annual rate of increase in
production. In 2015, the rate of increase starts to slow down and production will decline
after 2019 again according to EIA.
Why would we want to export oil when we will probably never import less than 37
or 38 percent (5.8 million barrels per day) of our consumption? For money, of
course!
Remember, all of the calls for export began when oil prices were high. WTI was around
$100/barrel from February through mid-August of this year. Brent was $6 or $7 higher.
WTI was lower than Brent because the shale players had over-produced oil, like they
did earlier with gas, and lowered the domestic price.
U.S. refineries cant handle the light oil and condensate from the shale plays so it
has to be blended with heavier imported crudes and exported as refined
products. Domestic producers could make more money faster if they could just
export the light oil without going to all of the trouble to blend and refine it.
This, by the way, is the heart of the Keystone XL pipeline debate. Were not planning to
use the oil domestically but will blend that heavy oil with condensate from shale plays,
refine it and export petroleum products. Keystone is about feedstock.
Would exporting unrefined light oil and condensate be good for the country? There may
be some net economic benefit but it doesnt seem smart for us to run through our
domestic supply as fast as possible just so that some oil companies can make more
money.
OP: In global terms, what do you think developing producer nations can learn from the
US shale boom?

Arthur Berman: The biggest take-away about the U.S. shale boom for other
countries is that prices have to be high and stay high for the plays to work.
Another important message is that drilling can never stop once it begins because
decline rates are high. Finally, no matter how big the play is, only about 10-15% of
itthe core or sweet spothas any chance of being commercial. If you dont
know how to identify the core early on, the play will probably fail.
Not all shale plays work. Only marine shales that are known oil source rocks seem to
work based on empirical evidence from U.S. plays. Source rock quality and source
maturity are the next big filter. Total organic carbon (TOC) has to be at least 2% by
weight in a fairly thick sequence of shale. Vitrinite reflectance (Ro) needs to be 1.1 or
higher.
If your shale doesnt meet these threshold criteria, it probably wont be commercial.
Even if it does meet them, it may not work. There is a lot more uncertainty about shale
plays than most people think.
OP: Given technological advances in both the onshore and offshore sectors which
greatly increase production, how likely is it that oil will stay below $80 for years to
come?
Arthur Berman: First of all, Im not sure that the premise of the question is correct. Who
said that technology is responsible for increasing production? Higher price has led to
drilling more wells. That has increased production. Its true that many of these wells
were drilled using advances in technology like horizontal drilling and hydraulic fracturing
but these werent free. Has the unit cost of a barrel of oil gas gone down in recent
years? No, it has gone up. Thats why the price of oil is such a big deal right now.
Domestic oil prices were below about $30/barrel until 2004 and companies made
enough money to stay in business. WTI averaged about $97/barrel from 2011 until
August of 2014. Thats when we saw the tight oil boom. I would say that
technology followed price and that price was the driver. Now that prices are low,
all the technology in the world wont stop falling production.
Many people think that the resurgence of U.S. oil production shows that Peak Oil was
wrong. Peak oil doesnt mean that we are running out of oil. It simply means that once
conventional oil production begins to decline, future supply will have to come from more
difficult sources that will be more expensive or of lower quality or both. This means
production from deep water, shale and heavy oil. It seems to me that Peak Oil
predictions are right on track.
Technology will not reduce the break-even price of oil. The cost of technology
requires high oil prices. The companies involved in these plays never stop singing the
praises of their increasing efficiency through technologythis has been a constant
litany since about 2007but we never see those improvements reflected in their
financial statements. I dont doubt that the companies learn and get better at things like

drilling time but other costs must be increasing to explain the continued negative cash
flow and high debt of most of these companies.
The price of oil will recover. Opinions that it will remain low for a long time do not take
into account that all producers need about $100/barrel. The big exporting nations need
this price to balance their fiscal budgets. The deep-water, shale and heavy oil producers
need $100 oil to make a small profit on their expensive projects. If oil price stays at $80
or lower, only conventional producers will be able to stay in business by ignoring the
cost of social overhead to support their regimes. If this happens, global supply will fall
and the price will increase above $80/barrel. Only a global economic collapse would
permit low oil prices to persist for very long.
OP: How do you see the global energy mix changing in the coming decades? Have
renewables made enough advances to properly compete with fossil fuels or is that still a
long way off?
Arthur Berman: The global energy mix will move increasingly to natural gas and more
slowly to renewable energy. Global conventional oil production peaked in 2005-2008.
U.S. shale gas production will peak in the next 5 to 7 years but Russia, Iran, Qatar and
Turkmenistan have sufficient conventional gas reserves to supply Europe and Asia for
several decades. Huge discoveries have been made in the greater Indian Ocean
regionMadagascar, offshore India, the Northwest Shelf of Australia and Papua New
Guinea. These will provide the world with natural gas for several more decades. Other
large finds have been made in the eastern Mediterranean.
There will be challenges as we move from an era of oil- to an era of gas-dominated
energy supply. The most serious will be in the transport sector where we are thoroughly
reliant on liquid fuels today mostly gasoline and diesel. Part of the transformation will
be electric transport using natural gas to generate the power. Increasingly, LNG will be
a factor especially in regions that lack indigenous gas supply or where that supply will
be depleted in the medium term and no alternative pipeline supply is available like in
North America.
Of course, natural gas and renewable energy go hand-in-hand. Since renewable
energyprimarily solar and windare intermittent, natural gas backup or base-load is
necessary. I think that extreme views on either side of the renewable energy issue will
have to moderate. On the one hand, renewable advocates are unrealistic about how
quickly and easily the world can get off of fossil fuels. On the other hand, fossil fuel
advocates ignore the fact that government is already on board with renewables and
that, despite the economic issues that they raise, renewables are going to move forward
albeit at considerable cost.
Time is rarely considered adequately. Renewable energy accounts for a little more than
2% of U.S. total energy consumption. No matter how much people want to replace fossil
fuel with renewable energy, we cannot go from 2% to 20% or 30% in less than a decade

no matter how aggressively we support or even mandate its use. In order to get to 50%
or more of primary energy supply from renewable sources it will take decades.
I appreciate the urgency felt by those concerned with climate change. I think, however,
that those who advocate a more-or-less immediate abandonment of fossil fuels fail to
understand how a rapid transition might affect the quality of life and the global economy.
Much of the climate change debate has centered on who is to blame for the problem.
Little attention has been given to what comes next namely, how will we make that
change without extreme economic and social dislocation?
I am not a climate scientist and, therefore, do not get involved in the technical debate. I
suggest, however, that those who advocate decisive action in the near term think
seriously about how natural gas and nuclear power can make the change they seek
more palatable.
The great opportunity for renewable energy lies in electricity storage technology. At
present, we are stuck with intermittent power and little effort has gone into figuring out
ways to store the energy that wind and solar sources produce when conditions are right.
If we put enough capital into storage capability, that can change everything.