Last week, as the coronavirus pandemic intensified, Saudi Arabia demonstrated how much oil still matters and how much power it still wields. Capitalizing on an economic crisis, the Saudis—not to be confused with OPEC—flooded the market with oil, when prices were already in freefall. In response, Russia and the United Arab Emirates also increased production.
Whether this unilateral action signals the end of OPEC—and it may—is less relevant than what it says about the future of oil affairs, something that will matter when we’re on the other side of the pandemic. Russia’s chief oil oligarch reportedly told Vladimir Putin that low prices “are great because they will damage U.S. shale.” They will, but not permanently. If what happened to America’s shale fields during the last price collapse happens again, Saudi and Russian hopes will be dashed.
In 2014, oil prices had started to slide down as markets were over-supplied by the rapid production growth in U.S. shale fields. Back then, a price collapse was similarly triggered when the Saudis sharply increased output. That action wrought havoc in U.S. shale businesses and sparked a wave of bankruptcies. This time around could prove worse because the overall economy five years ago was reasonably healthy; now we’re in the middle of a virus-driven recession. Cheap oil is small comfort when no one is taking vacations or flying, but the lessons from that period remain relevant.
When the Saudis last disciplined the oil market, the shale industry was only a half-dozen years old. After the dust settled, America’s shale-oil output came roaring back and actually grew more rapidly than it had previously. Why? After the carnage, the shale industry became far more productive: U.S. oil output per employee has doubled since 2015. That’s an amazing gain in any business. It’s also a direct measure of experience and technology at work.
As for the future, two relevant questions pertain: Just how much oil is still hidden in America’s shale fields? And is there any “juice” left in technology to unlock it at lower cost with the same, or less, labor? The answers: a lot, and yes. After all, we know exactly where the oil is located. No one “discovered” shale oil; instead, entrepreneurs invented a way to access it. And despite the astounding growth in production, today’s techniques can extract only 10 percent to 15 percent of the oil available in the shale rock. Technology remains the key to tapping more of that enormous resource. Since that technology is increasingly digital, not mechanical, the marginal costs of each new barrel will keep coming down.
Thus, we look at the biggest difference today compared with the last price drubbing: the maturation of an entire class of industrial digital technologies. The kinds of software automation and artificial intelligence that have yielded revolutions in other less physically challenging businesses—from retail to music and news—are now focused on the industrial sectors. Hundreds of startups are developing oil-field software. Major players in digital domains—including Microsoft, Google, and Amazon—all have “big oil” programs. A Barclays research report from January 2020, “Frac to the Future; Oil’s Digital Rebirth,” concludes that the industry has “at last seized on the promise of digital and is poised for a step-change in efficiency over the next five years.” Of course, this conclusion was made just before the current price collapse, which may slow things down.
But the shale industry’s structure is uniquely suited to digital proliferation. Rather than a handful of oil giants engaging in huge projects that take years to plan and fund, the shale industry is dominated by thousands of smaller businesses drilling thousands of smaller, cheaper wells that can come online in weeks and months, rather than years. Odds are that once the dust clears this time, we’ll see an acceleration of the cautious digitalization that has already started. While doubling production efficiency is in theory possible again, achieving only a fraction of that will put many producers back into profitable territory, even at low prices. Meantime, for those able to stay in business during this price cycle—and it won’t be easy or fun—software is the cheapest way to cut costs and squeeze out profits.
The digitalization trend will accelerate once prices rebound, and they will, for a simple reason: the only thing that has ever stifled oil demand is a massive global recession. But recessions always end. When businesses start humming again, and people begin traveling (and they will), oil-demand growth will reignite. There will be fewer producers, just as the Saudis and Russians hope; with commodities, however, such cycles always foretell a price spike. That spike, combined with digital efficiencies, will open enormous opportunities for investors currently sitting on the sidelines (itself another unique feature of the U.S. oil industry).
The companies that survive the beatings will ignite another shale super-cycle in U.S. production and once again take market share from the Russians and Saudis. For now, the Domestic Energy Producers Alliance—chaired by Harold Hamm, executive chairman of Continental Resources—plans to file a formal “anti-dumping” complaint with the U.S. Department of Commerce. If the case passes legal muster—there’s no doubt about the “dumping,” only whether it meets a specific legal definition—relief in the form of punitive tariffs will follow, but not soon. Meantime, Trump has ordered the Department of Energy to help domestic producers by purchasing oil for the Strategic Petroleum Reserve stockpile.
But after deploying all the conventional, if painful, tools from refinancing and restructuring to layoffs, a key to both survival and resurgence will come from new technologies. At the dawn of the industrial digital age, those new technologies also happen to pose the biggest risk to Saudi Arabia and Russia.