The recent decline in oil prices casts further doubts on the shale oil hype. Last summer the Energy Information Administration, or EIA, a branch of the US government, published a compilation of data on cash flow generated by major oil companies. It showed how flat oil prices had translated into a flat flow of cash coming from operation. The problem came from the expenditures side, which were much higher than the cash generated, around $110 billion for the fiscal year ending in March 2014.
Why did companies spend so much? Partly because low interest rates incentive firms to take on more debt, but also because exploration and drilling is becoming more expensive as the most accessible deposits are already in operation. To be able to maintain this level of spending, firms had to sell their assets and take on more debt. The situation has deteriorated rapidly for these firms since last summer, when these data were published. Brent oil prices fell by 20 per cent, from $110 in July to $87 today. WTI suffered a similar decline. Revenues for sales are suffering, further reducing cash flow.
In the case of firms that operate mostly in the shale gas and oil sector in the United States, the situation is particularly more complicated. First, because prices in the US are below international levels. The glut created by last years’ massive production has increased the differential between the WTI American reference and the international reference of Brent, which used to be at $1 or $2 and is now at around $7 to $8. Furthermore, some of the most important shale oil producing deposits in the United States, in particular the large Bakken field, sell at a discount to WTI, increasing the pressure on revenues.
Second, because costs seem to be rising faster in the US than elsewhere. Some costs are falling; firms are getting better at injecting sand, water and chemicals to free up the shale gas and oil. But, overall, costs are going up. According to the EIA, upstream costs rose by 12 per cent a year in the 2000-12 period due to rising rig rates, deeper water depths, and the costs of seismic technology. Not a single large oil project in the last three years has had a break-even price below $80.
In April the Wall Street Journal reported that, in 2012 and 2013, the 20 largest American exploration firms spend $30 and $11.5 billion more than they made as cash flow. Only a few of them, mostly those with international operations that compensate high costs in the US, are producing positive returns.
The third factor affecting the United States is that its two main deposits, Bakken and Eagle Ford, are already facing severe decline rates in their legacy oil production change, which refers to the production capacity of existing rigs (without counting the additional ones that might be added later). Declining rates are now at between 70,000 and 110,000 barrels per day compared to their plateau level.
In summary, a substantial part of the world’s production requires high prices to be sustainable. The Guardian recently quoted a report by Carbon Tracker saying the oil firms committed over a trillion dollars over the next decade to projects requiring prices above $95 to be viable. These projects might never come into production if low prices continue. Saudi Arabia’s strategy of maintaining production high and prices low might prove to be a smart move to reduce global production capacity and bring prices back up in the long run.
By: Francisco Quintana