Skip to main content
The Globe and Mail
Support Quality Journalism
The Globe and Mail
First Access to Latest
Investment News
Collection of curated
e-books and guides
Inform your decisions via
Globe Investor Tools
Just$1.99
per week
for first 24 weeks

Enjoy unlimited digital access
Enjoy Unlimited Digital Access
Get full access to globeandmail.com
Just $1.99 per week for the first 24 weeks
Just $1.99 per week for the first 24 weeks
var select={root:".js-sub-pencil",control:".js-sub-pencil-control",open:"o-sub-pencil--open",closed:"o-sub-pencil--closed"},dom={},allowExpand=!0;function pencilInit(o){var e=arguments.length>1&&void 0!==arguments[1]&&arguments[1];select.root=o,dom.root=document.querySelector(select.root),dom.root&&(dom.control=document.querySelector(select.control),dom.control.addEventListener("click",onToggleClicked),setPanelState(e),window.addEventListener("scroll",onWindowScroll),dom.root.removeAttribute("hidden"))}function isPanelOpen(){return dom.root.classList.contains(select.open)}function setPanelState(o){dom.root.classList[o?"add":"remove"](select.open),dom.root.classList[o?"remove":"add"](select.closed),dom.control.setAttribute("aria-expanded",o)}function onToggleClicked(){var l=!isPanelOpen();setPanelState(l)}function onWindowScroll(){window.requestAnimationFrame(function() {var l=isPanelOpen(),n=0===(document.body.scrollTop||document.documentElement.scrollTop);n||l||!allowExpand?n&&l&&(allowExpand=!0,setPanelState(!1)):(allowExpand=!1,setPanelState(!0))});}pencilInit(".js-sub-pencil",!1); // via darwin-bg var slideIndex = 0; carousel(); function carousel() { var i; var x = document.getElementsByClassName("subs_valueprop"); for (i = 0; i < x.length; i++) { x[i].style.display = "none"; } slideIndex++; if (slideIndex> x.length) { slideIndex = 1; } x[slideIndex - 1].style.display = "block"; setTimeout(carousel, 2500); }

When the economy slows down, wallets thin out and people have less money to spend. Drivers make fewer trips to the gas pumps. The demand for oil slackens quickly. The price of a barrel goes down. It's not rocket science.

What about the other side of the oil market? If producers have less money to spend, does production decline swiftly too?

Historically, the output response to lower prices has been slow, much slower than consumer thrift. But that lagging reaction may be history. Because of science and innovation, the character of world oil production has radically changed. Since 2009, oil output has rocketed up in the United States and Canada, and not much elsewhere (see Figure 1). That's not news. But what may be news is how vulnerable North America's growth may be to the dropping oil price.

Story continues below advertisement

The price of a barrel of international light crude oil – measured by Brent – has hit its lowest level in more than two years. Discounted North American oil prices are softening sympathetically; inside the continent, crude prices are at least $5 to $10 cheaper than barrels labelled with Saudi, Nigerian and British flags. Some oil price analysts, feeding off slowing demand fundamentals in Europe and China combined with growing Libyan production, suggest that price could weaken more. And while we agree that lower prices are possible in the short term, we do not expect price markdowns to be long-lasting.

Here is why. For oil producers, a crude oil discount translates into less cash flow, less appeal to capital markets and therefore less spending power. Yet not all oil production is affected equally by less investment. The world's 92 million barrels a day of oil production can be divided into four distinct types of production: Canadian oil sands; age-old onshore conventional wells; increasingly high-tech offshore production; and new-age hydraulically fractured tight oil.

Contrary to popular belief, oil will steadily flow from Canada's oil sands, even with lower prices. Massive sunk costs, scale, and negligible decline rates mean that most existing operations in the region will keep producing, even if the oil price for West Texas intermediate were to reach $55 a barrel (U.S.) or below. The resilience of oil sands production was proven out during the financial crisis: Oil supply remained steady when the price of oil dropped to under $50 in the last few months of 2008.

Overwhelmingly, the bulk of the world's output still comes from "conventional" vertically drilled onshore wells, combined with a growing wedge of supply from the larger scale and more technically challenging offshore projects. Historically, these production types have flowed reliably during low price episodes, and there has been a steady string of global megaprojects that have come online to offset legacy production declines.

But this landscape has changed. Producers from outside North America have been plagued with falling output, technical challenges, a lack of investment, outages due to civil war, corruption, sanctions or all of the above. New large megaprojects such as Kashagan or Brazil's deep-water subsalt have been long delayed. Organization of Petroleum Exporting Countries production is increasingly prone to outages. Even assuming that new international developments come on line, once declines from the existing production base are factored in, the collective capacity expansion from outside North America is flat at best. Or looking through the lens from the other side, the reverse argument is that U.S. and Canadian hydraulically fractured light oil fields will mostly determine the industry's free-market response to lower oil prices (OPEC may respond at some point, but that's another story).

North America's hydraulically-fractured, tight oil production follows a "just-in-time delivery" business model. When prices are robust, production can grow quickly, because each new well delivers very high initial production rates. However, high decline rates in these wells imply that output should fall off quickly when investment (drilling) is reined in. This downside hypothesis has never been tested, but if low prices were sustained, the economic experiment would be on.

Tight oil or shale oil exploitation is heavily dependent on the rapid recycling of cash flow and access to capital markets. Price weakness slashes unhedged cash flow. Price weakness also sours the appetite of capital markets to invest in oil companies. So production growth should moderate, or even retreat, with a low-price cash famine. This would, in effect, set a floor for the oil price. Depending on the rocks and the operator, the break-even price for North American tight oil varies widely. But we would expect that, notionally, the trigger price to start to witness an investment slowdown is about $85 a barrel for the West Texas intermediate benchmark (still about $10 under today's price).

Story continues below advertisement

The just-in-time nature of North American tight oil, combined with the difficulties in adding new supply elsewhere, suggests that the world's oil supply will quickly adjust to falling demand or surplus production. The lower prices go, the greater the probability they will rocket up again. But that's not rocket science either.

Peter Tertzakian is chief energy economist at ARC Financial Corp. in Calgary and the author of two best-selling books, A Thousand Barrels a Second and The End of Energy Obesity.

Report an error Editorial code of conduct
Due to technical reasons, we have temporarily removed commenting from our articles. We hope to have this fixed soon. Thank you for your patience. If you are looking to give feedback on our new site, please send it along to feedback@globeandmail.com. If you want to write a letter to the editor, please forward to letters@globeandmail.com.

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff.

We aim to create a safe and valuable space for discussion and debate. That means:

  • Treat others as you wish to be treated
  • Criticize ideas, not people
  • Stay on topic
  • Avoid the use of toxic and offensive language
  • Flag bad behaviour

Comments that violate our community guidelines will be removed.

Read our community guidelines here

Discussion loading ...

To view this site properly, enable cookies in your browser. Read our privacy policy to learn more.
How to enable cookies