Decline of US Shale Plays Not Clear Cut as Oil Price Stays Low

Ever since the oil price decline began in earnest back in July 2014, popular discourse has suggested US shale plays would be in deep trouble. Despite protestations to the contrary, other global producers are often accused of trying to stifle the American shale bonanza, and in some cases with good reason.

Initial forecasts about the imminent decline of US shale surfaced as early as October last year. However, assumptions about a wholesale decline in activity now appear to be exaggerated at best. There are also massive disparities in industry narratives about which shale play is workable at what price. Admittedly, there has been a slowdown but it is not as widespread as some had predicted.

It all bottles down to ingenuity of independent upstarts; the very lot who actually kick-started what we call a shale bonanza in the first place. Here a bit of perspective is required when looking at headline rig count data. The latest installment from Baker Hughes puts the number of operational US rigs, as of 27 March, at 1048 down by 761 from the same month last year. Drillinginfo, which uses GPS trackers (see illustration below) to monitor the rigs, found 1096 rigs over a comparable period.

Neither set of figures make for easy reading for the industry, but Tom Morgan, Analyst and Corporate Counsel at Drillinginfo, says making assumptions based on headline data miss one crucial point – efficiency gains.

“No one in the industry is pretending that a lower oil price doesn’t bite. Yet, technological progress over the last decade, especially in terms of horizontal drilling is reaping benefits when times are hard. Over the last three years, efficiency of shale explorers has increased by 25%; so in effect three years ago the profitability of $100 per barrel oil is the same profitability at $75 per barrel.”

Drillinginfo’s GPS trackers cover 80% of operational rigs stateside and the company squares electronic data with physical permit applications to interpret trends. Based on heat signatures (see illustration on page 2), the analytics firm opines that the biggest declines have been noted in the case of vertical wells drilled the old fashioned way, and by geography in North Dakota.

“Production in the Eagle Ford [Texas] is holding up and in many cases increasing. Shale players are also learning to do more with less. So an investment decline per se does not directly translate into a production decline,” Morgan adds.

Deborah Byers, Oil & Gas Leader of global advisory firm Ernst & Young ’s US practice, says assumptions often presented as facts on what does [or doesn’t] make shale plays tick usually fail to appreciate that each project, not just a particular exploration prospect, has its own profitability level which isn't pegged at $100 by default.

“So for instance, if late entrants to Bakken plays are in trouble with lower oil prices, Eagle Ford players who logged the most prolific and efficient production data last year, would continue to plug away at $35. Hedging will also keep many players going for the remainder of the year,” she adds.

Louis J. Davis, Chair of international law firm Baker & McKenzie’s North America Oil & Gas Practice, says smaller companies can operate at maximum efficiencies and at times produce oil cheaper than the larger companies.

“Survival instinct will also keep many players going. Conventional wisdom is that folks who invested in shale in the last couple of years probably paid a premium price. These players will have to drill in order to survive. While reluctant to sell acreage or holdings, they could seek partners or bridging capital, albeit at a higher cost, in anticipation of better days.”

Both Byers and Davis are also bullish on the ability of US producers to throttle back quicker and take supply off the market in order to be more nimble and efficient, but also be pretty quick to turn things back on. That said, Drillinginfo’s data coupled with wider empirical and anecdotal evidence suggests Texas is proving itself to be more adept at this than North Dakota.

Overall, Vincent Kaminski, Professor in the Practice of Energy Management at Rice University’s Jones Graduate School of Business, suggests there are several reasons why shale oil production will grow or keep pace at the very least but not collapse.

“First of all, most exploration leases have clauses that require drilling at least one well within a specified period of time. So if you don’t start drilling, the lease will lapse. That’s the biggest incentive, and for some perhaps an imperative, to drill. Furthermore, with technology related to horizontal drilling, it makes no sense to drill a single well; you will drill multiple wells on the same patch.”

“Secondly, many companies have already paid upfront for contracts with rail terminals; they will have to drill, produce and ship. It is also worth pointing out that some wells are located in places where it is cheaper to transport. Here, companies can maintain production at relatively low costs.”

Typically, a marginal cost or breakeven price is measured at the well. For some low quality Bakken plays, the marginal cost could be as high as $70-$80 per barrel, almost double the marginal cost of decent Eagle Ford plays. Unquestionably, it is at the former that the US has seen a decline in activity and output.

In any case, once an oil well is onstream, marginal cost is much lower as opposed to drilling a new well, and companies have all the incentive to squeeze out as much as they can from the existing wells to support activity and service their debt. The industry is also seeing an influx of private equity capital, as more traditional avenues of finance such as banking capital become difficult to get a hold of in the current climate.

Finally, Kaminski notes with some justification that most oil price predictions over the last 10 years have been catastrophically poor. “There could always be a [major] geopolitical development that may completely change the picture. The market is very sensitive to relative excess supply; it can go away in a blink say if OPEC changes its policy.”

Hence, blanket assumptions that shale oil output will invariably decline seem ill-advised at best. While not discounting market headwinds and the supply correction they are causing; the latter part of 2014 and the first quarter of 2015 have given ample reasons to believe the US shale industry is made of sterner stuff.

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