If it wasn’t clear before, it should be now. The Saudis have put a bull’s-eye on the U.S. shale industry: Sapient Global Markets’ Chip Register that examines the recent plunge in oil prices and potential responses for the U.S. market to consider.
Last week the Kingdom cut the selling price for its crude for the second straight month in a row. But unlike the last time, the Saudis only cut their price for oil bound for the U.S. market and nowhere else. Indeed, they actually increased the selling price of its oil to Asia and Europe, much to the relief of fellow OPEC members.
West Texas Intermediate (WTI) crude, the U.S. oil benchmark, fell sharply on the news, trading down at a three-year low of around $77.84 a barrel. WTI is now down a whopping 30% since June when it traded at a high of around $108 a barrel. Oil analysts have responded. Goldman Sachs moved markets last week after the investment bank cut its 2015 oil price target for WTI to $75 from $90 a barrel.
There is now growing concern among investors that such low prices may force many U.S. shale producers to close up shop. Indeed, Deutsche Bank claims that 40% of U.S. shale oil production scheduled for 2015 would be uneconomic below $80 a barrel, a damning statistic. The chief economist over at theInternational Energy Agency (IEA) backs up the Deutsche Bank claim, recently noting that U.S. shale oil production needs prices to be around $80 a barrel in order to be profitable.
In my previous column, I posed a pretty provocative question – Is it time to save the Shale Revolution? I examined the possibility of the U.S. government raising trade barriers in the form of import taxes to protect the industry from collapse, much the way it does for many other commodities, like agricultural products. The article argues that continued investment in domestic drilling provides an economic and geo-strategic advantage to the nation that should be coveted, not left exposed to the whims of foreign leaders. For even asking this question aloud, I was labeled no less than a “market-skewing statist.”
Can U.S. Shale Interests Survive At Such Low Prices?
But is government intervention is really even necessary or helpful, or can the industry make the numbers work in a low oil price environment?
The Deutsche Bank figure has been held up by proponents of protectionism as a major reason to block foreign oil imports from ruining the U.S. shale industry. But how accurate are these figures? It turns out there is considerable debate within the energy community as to how low prices have to go to force shale drillers out of business. Indeed, the head of the IEA just recently contradicted her chief economist when she said that 82% of shale oil producers in the U.S. have a break-even price of around $60 a barrel or lower. Based on that, she didn’t see a major fall off in production anytime soon.
Meanwhile, the analysts over at Citibank say that weak oil prices haven’t made much of a dent in U.S. crude production and that drilling would continue to increase even if prices fell to around $70 a barrel. On average, they say, prices would have to fall below $50 a barrel before fully halting production growth in the U.S., with many drillers staying profitable if oil prices held between $40 and $60 a barrel.
So who’s right here? It’s hard to say. What we do know is that drillers today aren’t likely to be scared off by a few weeks or even a few months of cheap oil. For example, it took years for U.S. natural gas production to slow when prices in that commodity took a tumble in 2008 and 2009. Producers continued to pump in the hopes that prices would recover. One reason for this was because many simply couldn’t stop pumping as they were locked into long-term contracts that required them to deliver a minimum level of production, even if it meant they would lose money doing it. Failure to comply could mean the loss of the lease and any future upside when prices normalized.
But even though prices remain (relatively) weak today, natural gas production in the U.S. continues to be quite robust. Indeed, the U.S. is now the world’s largest producer of the stuff. While production did level off, it never crashed as some feared as the industry was able to adapt to the lower prices. As such, there is good reason to believe that such a scenario could occur in the crude arena as well.
Technology Innovation Can Boost Recovery Rates
There is a great deal of upfront cost associated with getting an oil field up and running, so it is unlikely that producers will just hit the road the moment things get a little tough. Indeed, many have already sold their production forward and locked in high prices. That should shield many companies from having to deal with today’s weak prices for some time.
In the long run, though, technology will probably provide the greatest efficiency gains for producers. The Shale Revolution was sparked by advances in fracking and horizontal drilling technology, so innovation is at the heart of this movement and will continue to push it forward. Shale productivity per new well has increased 800% in the last six years thanks to advances in technology, but producers are still leaving a lot of oil in the ground. Indeed, the current recovery rate from shale oil formations is only around 5% of what is possible, according to Robert Kleinberg, a fellow with Schlumberger, the large oilfield service firm. That is far below the average 50% recovery rate for conventional wells, Kleinberg says.
Producers and oilfield service firms are working furiously on developing Enhanced Oil Recovery (EOR) techniques that can help them boost production, specifically in unconventional shale wells. EOR is a generic term used by oil service firms describing a basket of new technologies that they are developing to help producers squeeze more oil out of fields than what is currently possible.
EOR techniques that work for conventional wells, such as water flooding, don’t do as well in unconventional wells due to the “tight” formation of the rocks as it prevents water from moving freely in the formation. Oilfield scientists are having better luck injecting gas into shale wells using C02 and other so-called “miscible” gases to help push the oil out. This has been shown to increase overall oil recovery rates by as much as two to three times that of primary recovery techniques.
Wood Mackenzie, the energy consultancy, now estimates that EOR technologies currently being explored today by producers and which are set to come into force by 2020, could add 1.5 to 3 million barrels per day to U.S. production by 2030, up to 25% more oil than what is being forecasted today. With the success of ASP Floods, that number could be considered very conservative.
Exporting Oil and Keystone
If all else fails, though, there may be one place for government action; but instead of raising trade barriers, the U.S. may have more luck in combating the Saudi’s and others by allowing U.S. oil producers to compete against them on the world stage by reversing a long-standing ban on exporting crude oil from the U.S., which covers all states except Alaska.
Indeed, greater competition and a more open market may be just what are needed here to revitalize the shale industry, as oil currently trapped in the U.S. and trading at a discount to the Brent benchmark, could find a home elsewhere and capture greater margins.
With the Republicans winning the Senate in this week’s election, there is now a greater chance for the Keystone pipeline to be built, which would send oil from Canada down to the U.S. refining center in Texas. If the oil export ban is lifted, production from the Bakken region of North Dakota could ride the Keystone down to be exported via the port of Houston to Europe. New pipelines connecting oil plays with ports on the West Coast could make it much easier to transport oil to the energy hungry Asian markets.
But for now the oil patch is humming along despite the drop in prices. And while some oil production will inevitably be sidelined if prices continue to weaken, the industry won’t disappear overnight. Indeed, if anything, it could push producers to consider more efficient capital structures and explore new technologies that could make it cheaper and easier to drill. All this should give hope for those fretting about the end of the Shale Revolution or protectionist sentiments welling up in the United States.