There was a time when the mention
of oil drilling conjured images of a gusher, about 50 - 100 feet high, men in
orange overalls dancing the jig and even screaming - we're rich ! we're rich !
The oil drilling business has moved on, and how. The Gas Liquid Chromatograph (GLC)
which analysed the percentile components of hydrocarbons in the crude find, was
the size of a truck. Now it's more like a desktop computer. The standard gas oil
separation plant spanned acres, now that too has shrunk. The drill bits were
made of hardened alloys to permit drilling in the toughest of high sediment /
minerals terrain. Now Schlumberger (world leader in drilling equipment) makes
diamond tipped drill bits. In the days gone by, going past the gas-oil "window"
depth risked men and equipment alike, as explosions destroyed both. Merely 4
decades ago, oil wells that lost 50% of their "pregnancy" were abandoned as
extracting the remaining oil at the bottom of the barrel was unviable
commercially. Now steam, surfactants and other additives constitute enhanced oil
recovery (EOR) techniques that scrape the residual oil upto 25 - 30% pregnancy
level. Seismological apparatus is more sophisticated than ever to gauge the
commercial potential of the earmarked terrain before drilling can even begin.
What is the point in this info?
That it costs more money to drill a barrel. What if a driller buys diamond bit drill bits ($ 1,25,000 per piece) and finds no oil after exhausting 3 drill bits? Should he drill deeper or maybe 100 feet away ? Tough question, considering that more drill bits will mean another half a million dollars (in salaries, equipment & rentals) in expense. Insurance costs of drillers for onsite personnel has skyrocketed. EOR (enhanced oil recovery techniques) cost a bomb and yield thick, high paraffin, low grade crude oil that reduces profitability ratios. The light sweet, low sulphur crude that rises to the top has already been harvested like the proverbial low hanging fruit. The truck-to-desktop sized Gas Liquid Chromatograph (GLC) is more accurate and portable, but entail higher costs. The Gas-Oil separation plants are more complex and technology driven - again higher costs. As the world drills deeper, the quality of crude is getting heavier and poorer in energy yield values. Refining plants that can handle such heavy crude have to be higher on the "Nelson complexity index" - a huge cost again. The point is, it's never about the direct cost of extracting a barrel of oil from the ground. Consensus views in the public domain notwithstanding. The driller must add the cost of every Schlumberger diamond drill bit he used - even on wells that turned out to be empty duds. The oil company aggregates the insurance costs of men & machines across it's assets before determining the selling price of its crude oil - one of most overlooked factor among many such similar factors. The marginal costs of producing oil are therefore significantly higher than the direct extraction costs - one of the least understood aspects of the game. Add the profit motive with usual 'additional factors' and you know where we are headed in the next 2 quarters at best.
Much like Benjamin Grahams tenets of value investing in equities, commodity markets have their own tenets too. You should know where you stand at any given price point. Wish you an oil gusher of a financial year 2015 - 16 in advance.
Vijay L Bhambwani