The impact of US shale oil on the Middle East

06 April 2015

Cheaper production could spell disaster for many of the region’s conventional oil fields

The unconventional oil revolution being witnessed in North America could have dire consequences for the region. This is not just because high shale oil production is keeping prices low, but because research and development (R&D) is now so focused on making unconventional production cheaper, maturing conventional oil fields may just become commercially unviable to the extent of them being rendered obsolete.   

The main historical difference between conventional oil field wells seen in the Middle East and the shale oil wells in the US is that the conventional wells last far longer.

This has always been the financial buffer for the region’s oil producers in that if a well has an operational lifespan of 20 years it is almost certain that the upfront costs will have been recouped.

This means a marginal profit should be made every year against operational costs of production even if the market witnesses a major drop in prices. Most conventional oil fields can withstand this downward trajectory in the short-term and even in the unlikely situation where production was halted, it would soon result in an uptick in price.

Oil shale wells last for far shorter periods and fracking, the hydraulic fracturing process that enables oil shale production, requires expensive horizontal drilling as well as water and chemical injection systems.

There is already a feeling that a tipping point has been reached in the US and that many international oil companies (IOCs) and oil field services companies are now concentrating their efforts on building up their unconventional capabilities at the expense of conventional production.

There are already some US shale formations offering break-even production prices of $25-$30 a barrel and many in the US believe that this could only be the beginning.

The US’ Occidental Petroleum even attempted to sell its Middle East assets in a bid to concentrate more on its core North American interests. However, the downward trajectory of the oil price in the second half of the year meant it was unable to secure a deal.

The fall in oil prices had an even more negative effect in the debt-heavy US exploration and production market, triggering almost immediate job losses that eventually ran into the tens of thousands.

However, it also underlined the absolute necessity of making fracking cheaper and more efficient and this is what is pushing the boundaries of R&D in the US.

The fall-out from cheaper oil shale production would mean that for some oil economies staring down the barrel of lower-yield oil fields coming to the end of their operational lifespans, spending hundreds of millions, if not billions, of dollars to maintain 50,000 or 100,000 barrels a day for another 10 years of production may not be worth the investment.

This is especially true in the Middle East where huge subsidies on domestic oil consumption are putting an even greater strain on government revenues.

There may be some crossover breakthroughs in technology that would enable lower-yield fields to cut costs through less drilling and higher efficiency. But with oil prices looking likely to remain at around $50 a barrel for at least another five years it will probably not be enough to justify large-scale capital expenditure for any fields that do not already have extensive enhanced oil recovery (EOR) systems in place.

The paradigm shift in priorities may force some of the region’s producers to look at adding more domestic value to natural resources with investment in oil refining and petrochemicals facilities. Lengthening the value chain is one way of cushioning the impact, but would require billions of dollars of initial investment. However, a commitment curbing subsidies would be one way of paying for it.

Oman is already going some way towards adopting this model with extensive downstream investments across the country. For others such as Qatar, its gas reserves may mean that the majority of the lower yield fields are allowed to slowly deplete.

The US is set to replace Saudi Arabia as the world’s largest oil producer by 2020, but the kingdom’s supergiant oil fields will enable Riyadh to maintain its market share and its ever-growing industrial base will be able to absorb a large portion of production.

However, the prognosis for the smaller producers is far less positive and a long-term strategy to tackle the growing influence of unconventional oil is essential for many of the region’s economies reliant on hydrocarbons.

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