CGES Global Oil Insight, Bi-monthly Focus, September-October 2013

Executive summary

More from less: how tight oil changes supply

Tight oil is now the main source of new supply - eclipsing the contribution from mega-projects favoured by the major oil companies. Despite spending billions of dollars, the majors have failed to boost their collective production, as rising costs, management constraints and technical challenges have delayed start-ups. Without smaller-scale investment in thousands of tight oil wells - mainly by independent companies in the US - non-OPEC production today would be no higher than it was in 2009.

Tight oil fundamentally changes the scale of upstream investment, making it less lumpy and more competitive. Although it is more capital intensive per barrel produced than deepwater or oil sands mega-projects, tight oil capacity comes in much smaller increments, reducing the barriers to entry for new participants and diluting risk. The economic characteristics of tight oil are also very different to mega-projects, creating a new tranche of supply that is more responsive to price.

Instead of a single mega-project costing $10 bn funded by a small consortium of major oil companies that will deliver more than 100,000 bpd of peak capacity five or more years after the final investment decision has been taken, the same money buys over a thousand wells costing $8-10 mn that can be funded by a large number of smaller companies and will begin to ramp up supply within months of the first well being drilled.

Such changes in both the scale and price-responsiveness of oil supply at the margin are profound. Throughout the history of the industry, the recurrent characteristic of oil supply is that it is both large-scale and price-inelastic, making oil prices inherently highly-volatile and requiring some form of intervention to avoid boom-and-bust cycles.

If tight oil has enabled the oil industry to become more "self-adjusting" by reducing the scale of investment necessary to create new supply and making that supply more price elastic, OPEC - and Saudi Arabia, which now acts as the swing producer within the organisation - may find it easier in future to keep the market in balance.

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