The US shale oil industry has gained a reputation for its flexibility by easily adjusting cost-efficiency to the wild swings in prices that have rocked the entire energy market over the past twelve months. Shale oil derricks are easy to put out of commission when oil prices drop only to get them working again should prices rise. However, this time around, shale rig productivity seems to have exhausted its sustainability as recent data indicates a stagnant balance between cost-efficiency and the actual value of crude output by most US energy small caps.
Such a situation may potentially invoke a decline in US crude inventories, eventually pushing oil prices up, effectively resolving the current oversupply glut in global markets.
Crude oil prices have been falling for roughly 16 months now due to the shale boom in the US.
Smaller energy companies managed to drill oil wells at low cost, extracting significant volumes of oil they put straight to the market. The abundance of crude and low production costs undermined the oil price that dropped from above $100/bbl in summer 2014 to the current $50/bbl. Even though most shale oil small caps were believed to have had breakeven rates at about $70/bbl, most of these companies survived the crash in prices.
The reason is that the production from each oil derrick has since risen by 30% as shale extracting technology is still being perfected, while companies' management idled less profitable rigs and intensified production off the richest oil spots in a matter of days. Efficient cost-management allowed for most shale oil companies stay afloat even when crude prices plunged to nearly $40/bbl.
According to the reports, productivity either dropped or was stagnant in the three richest oilfields in the US (the Permian Basin and Eagle Ford in Texas and the Bakken in North Dakota) in July through September, coinciding with a stabilization in the crude market. The EIA expects the November oilrig productivity to remain on its current levels, an estimated 465 bpd.
Another risk of the shale boom is that, in a similar fashion to ‘gold rushes' of the past (California and Klondike), the actual oil derrick output might fall as much as 70% in the first year of extraction as shale oilspots tend to exhaust quicker than regular oilfields. That said, shale oil companies also need to implement stricter time-saving regulations in order to maximize extraction per rig as long as it is profitable, while simultaneously embark on drilling new oilwells and recommissioning the previously idled derricks. Either way, production costs will climb gradually, pushing oil prices higher.
Nonetheless, even amidst the productivity decline crude extraction at Eagle Ford was 145,485 bpd in September 2014 compared to only 6,293 bpd in September 2010, before the shale oil boom. The amount of active oil derricks is falling nevertheless, and the EIA expects crude output to drop roughly 10% by next August. The US oil production peaked in April 2015 at 9.6 mln bpd, and is set to settle at 8.66 mln bpd in August next year.
However, it is impossible to predict the exact dynamics in the US production over the coming year. Although fracking technology advances have stalled, imposing limits on cost-efficiency, it is yet unknown whether or not new discoveries in extraction tech will be made.
Meanwhile, there is financial pressure mounting on shale small caps. According to Baker Hughes, the oil servicing company, whilst crude supply is falling, most companies are heavily indebted as they expected higher profits. At $100/bbl oil, investment in energy was abundant, but after prices dropped below $60/bbl, capital became scarce, and many companies issued bonds. Shale small caps attracted some $9.1 bln in bonds in Q1, adding $10.1 bln in Q2, but only $1.7 bln in Q3. That said, as bond liquidity wanes, risks mount and yield goes up, stirring concerns of financial insolvency.
Amidst productivity limitations and tightening financial conditions, the weakest companies in the industry are bound to collapse, resulting in lower overall output. A temporary relief in terms of prices, say, $70-80/bbl oil, would, however, provide a new push to the US extraction. Still, in a different market environment, global oil supply and demand might rebalance at a higher price of crude.
