David Flynn: What Oil Price Is Profitable?
The old saying goes that a picture is worth a thousand words. Clearly the idea is that one good image could relay information better than a lengthy description. There are two issues with that: 1) it needs to be the right graph, and 2) the graph may need at least some explanation. I think this is true of the North Dakota oil story right now. Those who watch these things will not find anything new or exciting in the following graph.
Oil production in North Dakota takes off, continues to grow, with some variability, and only recently even thought about leveling off. It is worth noting that this hardly looks like a “bust” in the oil economy. Instead, this looks like a pause in the growth cycle. It is entirely possible this could end up being a peak, but we would need to see a further decline before making that determination. The price picture is pretty familiar too.
These picture are somewhat used up though, that is, there is little more they will contribute to discussions now. This is particularly true of the overall production graph. So it is time to consider the year-over-year change in the production numbers.
I use the year-over-year approach to account for seasonal aspects in oil production. This graph tells a very important additional element to the story. At the tail end of Figure 1, we might be tempted to talk about a decline in oil production, and in absolute terms that happened. However, if we look at year-over-year production in Figure 3, we see the industry continued to expand output, even over the last year when price drops were enormous (see figure 2). In fact, you need to go back to February of 2004 to find a time when the year-over year numbers were negative. That is 138 consecutive months of growth over the same month in the prior year!
Now where does profit enter this story. Figure 3 displays a decline in the pace of increase in the oil industry, but after 138 months, can we be so picky as to declare an end to an industry based on that? I guess the answer is yes we can, but I think that would imply unrealistic expectations. The continued expansion of the industry even during a time of drastic drops in prices surprised many, including me to be honest, but it leads me to the following conclusion: we need to reassess the price point for profitability in the North Dakota oil industry. If we stick to conventional wisdom of $70 or $40 per barrel for profitable extraction we would think most of these firms are irrational, and while there are always those firms and individuals that make odd decisions at times to blanket an entire industry with that label is suspect. The fact of the matter is technological change is a big story in the oil industry in North Dakota, and maybe bigger than we realized.
Perhaps the continued growth indicates, at least for some, an ability to continue to generate returns sufficient to keep going and that stories of a North Dakota oil bust, or as some on twitter said this week, a “capitulation” of the North Dakota oil industry are overblown.
