U.S. markets open in 5 hours 56 minutes

Will Shale 2.0 Lower Oil Prices to $20 Per Barrel?

A paper called "Shale 2.0: Technology and the Coming Big-Data Revolution in America's Shale Oil Fields" was released in May by Mark P. Mills, senior fellow for the Manhattan Institute and faculty fellow at Northwestern's McCormick School of Engineering and Applied Sciences. The Manhattan Institute has a political ideology and the paper argues for certain government policies to be put in place. It is not the intent of this post to discuss policy recommendations, but instead to review the author's discussion on how emerging trends in the oil industry could lead prices lower. The author makes the claim "Shale 2.0 promises to ultimately yield break-even costs of $5-$20 per barrel-in the same range as Saudi Arabia's vaunted low-cost fields."


Shale oil is an unconventional oil that is produced by horizontal drilling and hydraulic fracturing. Unlike conventional oil, shale oil does not collect in liquid reservoirs. Shale oil is trapped within the rock and must be stimulated for producers to extract oil. The techniques of horizontal drilling and hydraulic fracturing (or fracking) are not new. Fracking was first commercially used in the late 1940's and horizontal drilling was used as early as 1929.

In 1981, a company named Mitchell Energy & Development Corp. faced tough economic times and began experimenting with fracking. Its founder George Mitchell is widely credited as being the pioneer of shale oil. It wasn't until the late 1990's that the company proved fracking could be economically viable. During the 2000's, many drillers entered the market and continued improving production techniques. As a result, shale oil was the primary reason American oil production increased by 1.2 million barrels in 2014 alone, and oil prices have dropped from over $100 per barrel to current prices.


Why shale oil prices will continue to fall

Mills believes that one cannot discount the possibility that oil prices will stay below $60 per barrel for decades. He points out that in the last 150 years, there have only been three periods where oil has risen above inflation adjusted prices of $50 per barrel.


Many shale producers started their ramp up in the mid-2000's when oil ranged from $50 to $60 per barrel. When oil shot up above $100 per barrel, innovation took a back seat to getting oil out of the ground. Shale producers adopted an assembly line approach where many operators used the same drilling process irrespective of each site's unique geology. The best producers, however, were more strategic in their drilling techniques and yielded more oil per well.

Mill's main thesis is that technological innovation continues to improve in all aspects including logistics, planning, seismic imaging, well-spacing, fluid and sand handling, chemistry, drilling speed, pumping efficiency, instrumentation, sensors and high-power lasers.

Technological improvements during Shale 1.0 (up to the present):

  • Improved equipment like the delivery truck below that converts into a sand silo

  • Improved drilling rigs with higher horsepower that allows producers to drill deeper and faster. Many older rigs have between 500 to 700 horsepower. Shale rigs need a minimum of 1,000 to 1,500 horsepower
  • Walking rigs that allow producer to drill multiple wells from a pad. Walking rigs also diminish the need for trucks at the drilling site

  • The result is that production per rig has increased dramatically. The graphic below depicts expected efficiency gains by variable over a four-year period.

  • New chemical mixtures that more effectively stimulate the rock
  • More powerful pumps that can apply more pressure, use more sand and transport the propellant faster

Looking ahead to Shale 2.0

  • Mills argues that Big Data and better communication will drive future improvements
  • "Big-data analytics can already optimize the subsurface mapping of the best drilling locations; indicate how and where to steer the drill bit; determine, section by section, the best way to stimulate the shale; and ensure precise truck and rail operations"
  • As an example, Haliburton claims to have reduced the cost of delivering a barrel of oil by 40% with its analytics techniques
  • Drones will also survey drilling areas and collect data
  • Drilling sites will have more internet connectivity which will improve equipment uptime, decrease maintenance time, and improve worker productivity and safety
  • COP uses sensors that extract data by minute. Big data is collected through wireless networks and have yielded production gains from existing wells by 30%
  • He is particularly optimistic because there is a lot of room for improvement in recovery rate and stimulation techniques. For example in drilling horizontally, most wells get 80% of the oil from 20% of the length stimulated
  • Note: When the author discusses production improvement percentages by Haliburton or COP, he doesn't specify a timeframe i.e. one-year, two-years or five-years?


The U.S. shale oil industry has disrupted the supply side and caused prices to fall. I have no idea if the author's prediction of $5 to $20 per barrel oil will come true. No one can accurately predict the numerous other factors that impact oil prices like geopolitical events, demand fluctuations, legislation, etc. What's important is to keep abreast of industry developments and for investors to comprehend potential outcomes. To read Mark P. Mills' full paper, you can go here.

This article first appeared on GuruFocus.