Shale oil needs a rapid rate of investment

Letter to Editor, Financial Times, 8 January 2015

Sir, Ronald Cotterill (Letters, January 6) is right to point out the importance of the relationship between high sunk and low variable costs for the oil industry. But oil production capacity is also a depleting asset that must be replenished by new investment, which is why full-cycle costs are still important in the longer-run.

What matters is how fast production capacity is depleting and therefore how much new investment is needed to maintain or expand output. Shale oil is different: to sustain capacity companies must keep on drilling because output declines very rapidly after initial production. The output from a typical North Dakota Bakken shale oil well falls by 65 per cent in the first year. This production profile is unlike a conventional oilfield where output may be sustained for years.

Such rapid decline rates mean that the full-cycle cost of investing in shale wells is an important consideration in determining where oil prices will bottom out. The US Energy Information Administration estimates that "legacy" capacity in the Bakken region is depleting at 77,000 barrels a day each month. Although capacity is still being added at a slightly faster rate of 104,000 b/d each month, about 160 new wells must be drilled every month to achieve this.

Lower oil prices are already discouraging investment in US shale. Fewer rigs are active and companies are slashing upstream budgets. Without new investment US shale oil capacity would deplete at about 300,000 b/d a month says the EIA. The long-run costs for shale oil kick in over a much shorter timescale than other sources of supply. While variable costs may dictate output decisions for conventional fields, shale production cannot be sustained - even in the short term - without further sunk costs.

David Long,

Director, Oxford Petroleum Research Associates,

Oxford, UK

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