Shale Producers Put to the Test

With oil prices dropping, U.S. shale producers are facing their biggest challenge yet: how to continue the momentum of recent years without the safety of high oil prices to ensure the profitability of continuously drilling new wells. Shale production isn’t cheap. Unlike convention oil reserves in the Middle East, where production cost per barrel is often less than $10, shale production can run $50-$90 per well. If oil prices slip below profitable levels, producers will have no incentive to keep pouring money into new wells. So how low do oil prices need to go in order to stifle the shale boom? According to Ed Crooks of the Financial Times, there is no clear answer. It varies from location to location and well to well. But one thing is clear: overall costs are dropping fast, and the amount produced per well is improving. According to research firm IHS, the median North American shale development needs a U.S. crude price of $57 a barrel to break even today, compared with $70 a barrel in the summer of last year. That’s a massive drop in an incredibly short period of time. Of course, these numbers represent the median production, and shale producers are constantly moving into more challenging territories. So right now, the race is on between prices and producers. Falling oil prices are creating new incentives for producers to see how efficiently they can operate, not only in order to survive, but also to try and maintain their revenue streams. A few weeks ago, we noted that Saudi Arabia and other Gulf oil producers are probably allowing prices to drift lower intentionally, in the hopes that it sidelines some of the shale boom and ultimately pushes oil prices back up. This new narrative, suggesting that Saudi is holding back on its typical strategy of price manipulation in order to squeeze shale producers (and, likely, Iran), has gained increasing prominence. But there is the possibility that this strategy could backfire—shale producers are unlikely to simply hang up their hat at the first sign of low prices, and it is possible that intense price pressure will only encourage further improvements in shale production technology, leading to greater innovation and even lower production costs. This is not to say that shale production will ever be as economical as the simple methods used to tap giant conventional fields in the Middle East, but shale producers are showing signs of resilience. As reported by the FT, EOG Resources, one of the most successful of the shale oil producers, cut cost per well in Texas from $6.9m in 2011 to $5m this year, while the average oil produced per well has increased. Meanwhile, consulting group Accenture believes the average cost of a US shale well could be cut by up to 40 percent if producers develop more efficient methods of organizing planning, logistics, and relationships with suppliers. Meanwhile, Harold Hamm, CEO of Continental Resources, another of the top shale oil producers, argues that most U.S. shale producers are well positioned to weather the price dip, but there will be a clear impact on future growth in newer plays. “When the market’s going up, you can overspend what your cash flow is, with confidence. But when the market’s going down, it’s not best to do that, because the debt market goes away,” he said. In other words, most existing production won’t be impacted by falling prices, but future production will certainly slow. This dovetails with findings from IHS, which reports that high oil prices, generally over $95 per barrel, are needed to “incubate” new plays. Therefore, while US oil producers are positioned to withstand the price dip, it will almost certainly derail shale production in other countries. Hamm noted that the shale boom is still highly price sensitive, and that if prices had dipped in 2012, producers would have suffered much larger consequences. Hamm also added that he doubts the decline in oil prices will last for long, stating, “It will correct, and it will come back.” He also remarked that as spectacular as the US shale boom has been so far, it won’t last indefinitely, stating that, “Before people get drunk on their own wine, they ought to realize that it’s not forever.” In other words, for consumers, enjoy low oil prices while they last.