Ghawar vs. the Permian – who would guess that a government-owned business would be run more wisely?

Petroleum reservoirs are not infinite. That might sound self-evident and/or stupid, but they are often treated as if they are. That can be a natural reaction as new fields are being developed, when the boundaries are still being delineated, and sometimes those enthusiastic thoughts just get stuck in everyone’s head.

The phenomenon happens everywhere, but always fades with time. Two of the biggest examples of the past 50 years are Saudi Arabia’s reserves and US shale production. For decades Saudi Arabia implied that it could indefinitely keep oil prices low if it wanted because its reserves could meet any realistic demand scenario. A more recent example is US shale production, which has everyone from Trump on down (that being a political and/or power hierarchy, not any other qualitative sort) proclaiming that the US will soon be self sufficient in energy, exporting large amounts to the world, and pretty much wiping out OPEC like Clint Eastwood would have, but without the cussin’ and shootin’.

In light of the reverence for which each was (or is) held, it’s interesting to look at the state of development of each. SA’s reservoirs are now as well documented as the Kardashians, whereas shale reservoirs are viewed as nearly endless pools which we’ve only begun to develop, and bizarre Permian production forecasts are being tossed around with straight faces like 5 year old boys casually discussing how far they can throw a car.

Realizing that their reservoirs are a one-shot wonder that they’ve been relying on for 80 years, SA has developed a whopping trillion-cell model of their entire oil producing region  – roughly the same number as Kim Kardashian’s selfie count. Recognizing the importance of their resource to themselves and the world, they have focused admirably on a complete understanding of the geology, and developing the fields carefully with the best technology they can buy.

The approach the Saudis have taken has been careful stewardship of a national treasure. And by treasure I mean a literal treasure, not a figurative one – imagine the Saudi economy if it never had fossil fuels. It would be similar to Antarctica in every dimension except the obvious one. The Kingdom therefore has been very wise in the careful development and stewardship of a non-renewable resource. It’s an age-old concept – farmers don’t sell or consume all their seed grain, loggers properly manage forests to ensure a harvest in perpetuity, etc. This mentality has always been important but is now crucial with 7 billion people to keep alive and warm.

Which brings us to the development of shale resources. While the Saudis have maximized the value of their resource through extensive analysis and careful development, US shale producers are following an organic model by emulating locusts.

It is not hard to come to this conclusion. Observe any shale producer’s promotional documents; they will brag about production growth and ever-longer laterals that drive down per unit drilling costs. All well and good, when one’s only standard of value is a short-term share price.

Maybe that sounds crazy, trash talking an industry that the whole world looks to as the permanent solution to high oil prices (up to and including the US president). Perhaps the message would be more meaningful if it came from someone other than the BOE Report’s resident crank. Oh wait, what’s this: A quote from the CEO of Anadarko Petroleum, one of the largest US shale producers, speaking to investors and the investment community: “The biggest problem our industry faces today is you guys. You don’t reward capital efficiency, you reward growth. When you guys stop rewarding growth and reward capital efficiency, guess what – and the share prices react, people will stop chasing growth for growth’s sake.”

That little speech encapsulates the problem, and acknowledges that it is a problem.

The US of course is not out to lunch, and has initiatives in place to do what the Saudis did. The government, the much-maligned government, has stepped in to do what should have been done years ago: try to understand what actually happens in shale fracks. The US Department of Energy’s National Energy Technology Laboratory last year plucked a 600-foot core out of a horizontal shale well, had a look, and had this to say; “Based on a first look at the core, the research team predicts that the fundamental understanding of hydraulic fracture propagation, modeling, and effectiveness is about to undergo a game-changing alteration.” Why no fracking company or major shale producer has not done such a thing is a confounding mystery. Oh hang on, mystery solved – it costs too much.

The Saudis know every nook and cranny of their reservoir and tailor drilling programs and waterfloods to maximize the whole. Shale drillers seek out the sweetest spots and drill as fast as humanly possible, blasting fracks with the all the restraint of monkeys with dynamite to extract a resource as quickly as possible in a competitive race to the bottom. The result of the first shale boom was to drive down prices and destroy billions in equity and debt, much of the latter being written off to zero. In this modest recovery, the participants are refining what’s worked best and are pounding away at very best spots of the shale plays at the same time that plentiful global supplies are destroying the value of the production. One day this will look like madness.

SA’s reservoir model, by contrast, displays an obvious desire to maximize the whole. It helps that a single entity owns the whole thing, of course, but nevertheless the effort was worthwhile. The model was achieved by loading the information from 150,000 cores into their simulator, in conjunction with known oil, water and pressure variables. Along with more than 60 years of production history, the Saudis now have a formidable understanding of the largest and most important oil reservoir complex in the world. The fact that, upon completion, they slapped a “for sale” sticker on the side is another story for another day.