What a North American oil slowdown means for global supply

The most important thing you need to understand about the coming oil production cutbacks is where they are going to come from, namely Canada and the United States.

Matt Slocum/AP/File
A pump-jack works in an oil field in Van, Texas.

What the current oil price slump means for world oil supply is starting to emerge. "Layoffs," "cutbacks," "delays," and "cancellations" are words one sees in headlines concerning the oil industry every day. That can only mean one thing in the long run: less supply later on than would otherwise have been the case.

But perhaps the most important thing you need to understand about the coming oil production cutbacks is where they are going to come from, namely Canada and the United States.

Why is this important? For one very simple reason. Without growth in production from these two countries, world oil production (crude oil plus lease condensate which is the definition of oil) from the first quarter of 2005 through the third quarter of 2014 would have declined 513,000 barrels per day. That's right, declined. Including Canada and the United States, oil production rose just under 4 million barrels per day.

That means substantial cutbacks in the development of new oil production in Canada and the United States could lead to flat or falling worldwide oil production.

But, why will any oil production cutbacks come primarily from Canada and the United States? For another very simple reason. Post-2005 oil production growth in these countries came from high-cost deposits in Canada's tar sands and in America's tight oil plays. New production from these high-cost resources simply isn't profitable to develop in most locations at current prices.

Of course, there are various figures floating around about what price level will allow new production to proceed profitably in these deposits. Some of those figures closely match current oil prices. But, we should look at what the oil companies are doing, not what they are saying. And, what they are doing is cutting back and cutting back drastically. Recent U.S. rig counts dropped the most since 1991, and rigs are being withdrawn from the very areas that were responsible for the tight oil boom.

 

Earlier in January Canada's largest oil company and a major oil producer in the tar sands, Suncor Energy Inc., announced layoffs, a cut in its capital budget and delays in new projects. Others are doing the same.

If the low prices continue, even more of the previously anticipated new production from these deposits will be delayed while production continues to shrink in the rest of the world. The twin North American engines for growth in the world's oil supply would stall.

If the world economy goes into a long-term slowdown or recession, then oil demand will ease further. That would mean lower prices would stick around for a while. But eventually, when growth accelerates, the pressure on constrained supplies may become acute and prices could spike.

By then, much of the workforce and machinery needed to increase production will be idle. But, probably more important, lenders and investors will be reluctant to risk money on tight oil and tar sands projects that only brought them grief the last time around. In all likelihood lack of capital will be the primary hurdle for Canadian and American operators when they attempt once again to ramp up production.

Even if oil prices recover soon to levels that would normally reassure lenders and investors, the growth in new production of U.S. tight oil and Canadian tar sands oil may only return to the hypercaffeinated rates of last summer several years from now after the memory of the recent financial carnage has faded.

Each day that oil prices stay low heightens the risk that the world will soon experience flat or falling worldwide oil production--something the oil supply optimists said simply couldn't happen with these new oil resources now available to us.

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