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Law360 (April 16, 2020, 4:48 PM EDT) --
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| Taylor Evans |
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| Scot Anderson |
The scale and sharpness of this decline is reminiscent of the dramatic drop in oil prices that began at the end of 2014, when the price of oil dropped from over $100 bbl to below $30 bbl by early 2016. At the time, the break even price for U.S. shale production was around $68 bbl. Thus, oil prices dropped well below the break-even price for U.S. shale production.
The drop in oil prices dramatically pressured U.S. shale producers, and some pundits thought that the low price of oil would be fatal to them. While some companies succumbed, many better-positioned shale developers survived the oil price drop.
They did so by rigorous cost control, and adopting more efficient operational practices and technology. Cost controls included renegotiating or terminating service agreements, and laying off substantial numbers of workers. The technological improvements were mainly operational — longer wells, more frack stages and more wells per pad — but some were technical, such as improved fracking fluid compositions, more powerful rigs and more sophisticated surface and drill stem technologies to better target reserves.
In the end, oil producers were able to maintain production and still be profitable. The U.S. Energy Information Administration data shows that the number of active rigs declined sharply during 2015 and 2016, but production in the U.S., and in key shale basins, remained relatively flat through this time period.
In some ways, the 2020 oil price decline is similar to the 2014-2016 decline. It has been precipitated by a price war between Saudi Arabia and Russia, and analysts predict that low prices will abide for quite some time. In other ways, this price drop is quite different.
Of greatest significance is the effect of the COVID-19 pandemic on the global economy. COVID-19 has already created a decreased demand for oil — flights have been cancelled, the movement of goods is curtailed and people are parking their cars in the driveway. The recession that results from the pandemic will likely lead to oil supply that far outstrips demand for some time.
Further, since the last downturn, oil and gas operators have largely maintained the cost saving measures implemented in 2015 and 2016. While there is some room to decrease third-party costs and implement operational efficiencies, there is simply less fat to trim from U.S. shale production costs.
As a result, shale operators may be required to find new and creative ways to lower the cost of production. The digitization of the energy industry may be accelerated by this need for efficiency.
Oil and gas producers are generating more data across more parameters, yet most of this data fails to inform the decision-making process, reduce costs or improve productivity. In many ways, oil and gas is the ideal industry to exploit the digital transformation because operations tend to span multiple regions, and involve large capital investments and extended supply chains.
As we move through the Fourth Industrial Revolution, companies producing from shale and unconventional plays may be able to use connectivity, the internet of things and similar innovations to realize cost savings and survive the Saudi-Russian oil price war. For example, Minou Rabiei at the University of North Dakota has been exploring ways to use artificial intelligence and big data to meet environmental regulatory requirements.
At first, algorithms might be deployed to gather data and satisfy environmental reporting requirements. Over time, these algorithms can learn how to optimize performance while meeting regulatory requirements. The system could even learn how to adjust physical operations to keep emissions within regulatory thresholds, or otherwise to assure compliance.
Producers may also be able to use data generated from drilling to find ways to enhance production. The World Economic Forum, for example, notes that a drill rig generates a terabyte of data, but very little of that data is used for decision making.[1] But what if that data could be organized to extend asset life, or drive additional profit?
The ability to detect patterns in data can save money. Imagine software, for example, that can perform predictive maintenance by using data from sensors at a well site to detect an impending compressor failure before it occurs, allowing for early mitigation and repair of the problem. Such technology can help to avoid downtime losses worth millions of dollars.
Digital technology can also be used to increase reservoir limits. For example, some technology provides for 4D seismic imaging, adding a time lapse function to traditional 3D imaging. This technology allows for measurement and prediction of fluid changes in reservoirs over time, which leads directly to increases in recovery rate and revenue.
Finally, the depressed oil price and the effects of the pandemic may slow the development of pipelines and other infrastructure. The Permian, Utica and Marcellus basins, however, remain subject to substantial pipeline bottlenecks. Producers and midstream companies can use data and AI to assure the most efficient use of transportation infrastructure, similar to the deployment of power on a smart grid.
These innovations, and others, have been in development. Once the more easily achieved cost savings are realized, producers may be able to accelerate these cost-saving innovations to take operational efficiency to another level. Our experience in 2014 indicates that the oil industry is capable of responding to this new set of challenges.
Taylor Evans and Scot Anderson are partners at Hogan Lovells.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] World Economic Forum, Digitization: A New Era in Oil and Gas (2017).
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