This article first appeared at The McAlvany Intelligence Advisor on Monday, March 15, 2015:
Just a quick look at the history of the International Energy Agency should convince anyone of its inefficacy: founded in 1974 at the suggestion of Henry Kissinger, its focus is on management of other peoples’ resources. Its mandate: the “3Es”: energy security, economic development, and environmental protection. The fact that it lacks any understanding of how the free market automatically addresses these issues showed up a month ago when its prediction of lower oil production in the US fell flat: “The U.S. supply [of crude oil] so far shows precious little sign of slowing down. Quite to the contrary, it continues to defy expectations.”
On Friday it confirmed its ignorance of how the free market works when it announced – surprise of surprises – that the week ending March 6th saw US crude production hit a new record of 9.4 million barrels a day.
With that announcement, crude for April delivery on the New York Merc fell to within pennies of the low set in late January. It wasn’t supposed to happen. After all, the active rig count has been cut in half, and so – using statist assumptions – production should be declining. Why isn’t it? The experts at IEA are searching for answers.
Here are some of them. First, there’s Moore’s Law, announced back in 1965 by Intel’s founder, Gordon Moore: the number of transistors on an integrated computer chip, thanks to technological breakthroughs, would double every two years. Over the decades Moore’s law has been proven to be so predictable that it forms of the foundation of long-term planning for the entire semi-conductor industry!
It turns out that Moore was too conservative. As the pressure to innovate and gain a competitive advantage builds, technology now is doubling those transistors every 18 months.
And so it is in the oil patch. As recently as five years ago it could take nine months to get oil out of the ground. Today? Less than 30 days! And those wells are vastly more efficient in getting that oil. In the Eagle Ford region in Texas, wells are producing oil an astonishing 18 times more efficiently than they were in 2008, and today’s wells are operating 65 percent more efficiently today than they were in 2013.
There’s “re-fracking,” a process of going back to old wells and using the improved technology to release much more of the oil that’s still available. This is vastly more efficient than drilling a new well: all the capital costs have already been incurred. The cost to lift a barrel of oil in an old well is a fraction of its cost in a new one.
There’s the Pareto Principle, better known as the 80-20 rule: 80 percent of the oil produced in the US comes from just 20 percent of the wells. Actually, it’s 82 percent, coming from just sixteen percent of the wells, but that’s close enough. Pareto first formulated his principle back in 1896 when he noticed that 80 percent of the land in Italy was owned by just 20 percent of the people, and that 80 percent of the peas grown in his garden came from just 20 percent of the pods. Sales organizations know that 80 percent of its sales come from 20 percent of their customers. And 80 percent of those sales are made by just 20 percent of their salesmen.
Friday’s announcement that half of all oil rigs have been “stacked” over the last few months caused no end of consternation. Shouldn’t that mean, according to the IEA, that production declines will soon follow? The folks at the agency really ought to get out more.
Competition is heating up in the oil patch as well, with service companies vying to keep their share of the (temporarily shrinking) pie. This will bring costs down even further, adding incentive to produce even as the price of oil continues to decline.
How does the free market accommodate such massive oversupply? Where will the excess be stored? Once oil tankers, rail cars, and tanker trucks are filled to overflowing, what then? Won’t that imply a practical, physical limit to production?
Not hardly. Drillers are storing the excess capacity in tanks near each of their wells, while others are happy simply to stop producing, considering leaving the oil in the ground as “underground” storage. At present there are more than 3,000 wells already drilled in North Dakota and Texas, just waiting to be completed. Some drillers are continuing to drill but are putting off completing them. As Harold Hamm, the CEO of Continental Resources, told his peers: “Save that money. Avoid selling that production in this poor market and wait for service costs to fall [further] before completing those wells.”
The combination of factors unfamiliar to the experts at the IEA, including market forces, laws, and principles like Moore’s and Pareto’s, continue not only to set new production records but leave those worthies scratching their heads. Their statist mindset simply cannot grasp how the free market, left alone, will provide solutions to problems long before they ever appear on the IEA’s radar screen.
The average American consumer, of course, is completely oblivious to all of this. All he is doing is continuing to happily drive, saving and enjoying the benefits the mysterious free market somehow delivers to the pump every day. It’s likely to continue this mysterious process – even to those experts at the IEA – keeping production up and prices low for much longer than anyone is predicting.
The Wall Street Journal: U.S. Producers Ready New Oil Wave
OilPrice.com: Oil Price Crash A Blessing In Disguise For US Shale
The Wall Street Journal: Oil Prices Tumble After IEA Warning
The Wall Street Journal: U.S. Oil Rig Count Falls Again in Latest Week
NYMEX Crude oil close on Friday, 3/13/2015