Commentary: The shakeout in US shale

Fuel Fix ^ | November 19, 2014 | Matt Smith

[thackney]

My favorite quote by H.L. Mencken is ‘a cynic is a man who, when he smells flowers, looks around for a coffin‘. A bit morose, I know, but this appeals to the contrarian in me. My second favorite is überly-applicable to US shale oil break-evens: ‘For every complex problem there is an answer that is clear, simple, and wrong‘. For there is no lack of estimates flying around as to the price level at which US shale oil production could be curtailed. The problem is, they all appear to be different.

The debate was ignited by OPEC, after comments from Secretary General El-Badri. The Libyan said late last month that tight oil (aka US shale) would be the first to be impacted by the drop in oil prices, stating:“If prices stay at $85, we will see a lot of investment, a lot of projects, a lot of oil going out of the market.” He said half of shale oil would be out of the market at a price of $85.

This view is at the high end of the range when it comes to estimates, with the IEA seemingly taking the other side of this bet. Executive Director, Maria van der Hoeven, said last month that 98% of U.S. shale plays have a break-even price of below $80.

The IEA’s Chief Economist, Fatih Birol, tempered this optimistic view in recent days, stating current low oil prices would hurt investment in the industry and likely hurt production growth going forward. That said, slowing production growth is very different from an Opecian view of ‘a lot of oil going out of the market’.

The below graphic of oil break-evens from the Wall Street Journal highlights the current conundrum faced. Not only are shale break-evens wide-ranging from play to play, but they can also wildly vary within each formation itself:

Further conjecture is stoked as oil prices have been unable to rebound back above $80. Oil producers on earnings calls are shrugging off the suggestion that this lower price environment is having any impact (either that or they are not being completely transparent).

The CEO of Halliburton, David Lesar – the world’s biggest provider of fracking services – endorses this notion somewhat, saying U.S. shale oil producers will be fine, as long as oil remains between $80 and $100. Meanwhile, signs of rigs being idled, from Texas to Utah is providing a counter-point to this argument.

The below chart from Goldman Sachs (via Zero Hedge) points to a price of $75 where production would start to slow, a number affirmed by other bank research:

In addition, the level of financial pain which each individual producer can withstand is going to vary wildly; larger producers may be more financially stable, while smaller producers may be more highly leveraged.

It was this Reuters summary of various bank estimates which instigated me to go all Mencken in the first place, as break-evens are so wide-ranging, given likely different methodologies and assumptions. The below graphic (pilfered from Business Insider) shows a similar trending to the above image, emphasizing the gravitation around the $80 mark:

So where does this leave us? Despite wide-ranging estimates, consensus indicates that some degree of US shale oil production would be impacted at around current levels. Whether this translates to a mere slowing in the rate of oil production growth due to lower future investments, or a more material crimping of production, is yet to be seen. But if OPEC seems intent on leaving this up to market forces as opposed to intervening to balance it, then it would appear we may well find out.

I leave where we started, and with a quote from H.L. Mencken: time stays, we go.

[Zhang Fei]

ISIS would need slaves to work the agriculture, and if we keep drones tearing up the farm...what food? what meat?

Apart from deliberately bombing civilians being a war crime, we don't have enough bombs to prevent people from farming. Heck, we'd be doing them a favor, helping them till the soil. They don't need slaves to farm - they have a functioning market economy. People are paid for goods and services.

[Kackikat]

Maybe but it has to be delivered to them, so why can’t Zero figure it out. And NO ONE said anything about bombing civilians...they have to sleep.

[Zhang Fei]

Maybe but it has to be delivered to them, so why can’t Zero figure it out. And NO ONE said anything about bombing civilians...they have to sleep.

ISIS lives among civilians who outnumber them 50 to 1. We can't starve ISIS because they have the guns (and tanks and artillery) and will always eat first.

[thackney]

Bottom line is that they're not doing anything drastic.

Thanks for the data and link. I didn't mean to suggest it was a drastic change. I had watched the trickle down from last summer.

Deep water and fracking have finally raised production levels to the point that prices have to come down for the market to clear.

I believe the recent significant change was Libya coming mostly back on line. Prior Libya shutdowns had been made up mostly by US Shale increasing production. As they recently started production ramping up, the slack was already gone.

I don't think the Offshore has really made much difference lately.

[Kackikat]

Okay, fine....so ‘you can’t get there from here’...no wars were ever won that way.

[Zhang Fei]

Okay, fine....so ‘you can’t get there from here’...no wars were ever won that way.

The practical reason Bush did not irradiate Afghanistan is because he would have been brought up on war crimes charges by the Dems at some future point in time, and gotten a life term (until he was pardoned by a sympathetic GOP president). Unless he was committed to living in exile in a country that doesn't extradite to the US (none, especially if Uncle Sam is willing to throw in some sweeteners), his hands were tied.

Bottom line is that the measures we take are limited by what present laws consider acceptable. 800 years ago, he could have sent an expedition to kill everyone they saw, and have had his actions greeted with universal acclaim at the domestic level. Not today.

[Zhang Fei]

I believe the recent significant change was Libya coming mostly back on line. Prior Libya shutdowns had been made up mostly by US Shale increasing production. As they recently started production ramping up, the slack was already gone.

OPEC numbers (which include Libya):

Data for this Date Range
July 31, 2014	32.16M
June 30, 2014	31.86M
May 31, 2014	31.82M
April 30, 2014	31.94M
March 31, 2014	31.82M
Feb. 28, 2014	32.44M
Jan. 31, 2014	32.31M
Dec. 31, 2013	31.70M
Nov. 30, 2013	31.50M
Oct. 31, 2013	31.99M
Sept. 30, 2013	31.95M
Aug. 31, 2013	32.67M
July 31, 2013	32.77M
June 30, 2013	32.62M
May 31, 2013	32.82M
April 30, 2013	32.75M
March 31, 2013	32.31M
Feb. 28, 2013	32.14M
Jan. 31, 2013	32.20M
Dec. 31, 2012	32.38M
Nov. 30, 2012	32.66M
Oct. 31, 2012	32.72M
Sept. 30, 2012	33.22M
Aug. 31, 2012	33.55M
July 31, 2012	33.29M

June 30, 2012	33.39M
May 31, 2012	33.29M
April 30, 2012	33.75M
March 31, 2012	33.49M
Feb. 29, 2012	33.48M
Jan. 31, 2012	33.12M
Dec. 31, 2011	32.80M
Nov. 30, 2011	32.50M
Oct. 31, 2011	31.68M
Sept. 30, 2011	32.05M
Aug. 31, 2011	32.00M
July 31, 2011	31.86M
June 30, 2011	31.61M
May 31, 2011	30.97M
April 30, 2011	30.94M
March 31, 2011	30.81M
Feb. 28, 2011	31.98M
Jan. 31, 2011	32.39M
Dec. 31, 2010	31.81M
Nov. 30, 2010	31.71M
Oct. 31, 2010	31.45M
Sept. 30, 2010	31.88M
Aug. 31, 2010	31.85M
July 31, 2010	31.80M
June 30, 2010	31.78M

OPEC's October numbers:

Supply from the Organization of the Petroleum Exporting Countries has averaged 30.72 million bpd in October, down from a revised 30.84 million bpd in September, according to the survey based on shipping data and information from sources at oil companies, OPEC and consultants.

In other words, the glut isn't coming from an increase in OPEC production.

[zeestephen]

“Starving ISIS”

Not sure that makes sense.

Most of ISIS wells are in Iraq, and some in Syria.

I will guess that ISIS production costs are reasonably close to Saudi production costs, which are around $10 per barrel.

[zeestephen]

A couple weeks ago I saw two oil economists on CNBC.

One of them said that financing for new wells in North America would completely stop if the price of oil goes below $67 per barrel.

WTI is currently trading at $76.

[zeestephen]

Re: “For American shale plays, natural gas is the ace in the hole”

Not sure I agree.

In many USA shale formations natural gas is being flared off, mostly because the cost of recovery and transport makes it unprofitable.

Unless natural gas stays above $4.50 for an extended period, not just in the winter time, the natural gas revolution may have to wait.

[zeestephen]

Bush had the option to pardon himself, didn’t he?

[Zhang Fei]

Bush had the option to pardon himself, didn’t he?

Had. Couldn't pre-emptively pardon himself. His AG would not pursued an indictment. But any Democratic administration would have. No statute of limitations on war crimes.

[Smokin' Joe]

In many USA shale formations natural gas is being flared off, mostly because the cost of recovery and transport makes it unprofitable.

Infrastructure generation backlogs are a significant part of that, at least in the Williston Basin. You need the pipelines to gather it, and the gas plant to send it to. The expansion in production has generated a shortfall in processing infrastructure.

[cynwoody]

800 years ago, he could have sent an expedition to kill everyone they saw, and have had his actions greeted with universal acclaim at the domestic level. Not today.

800 years ago? Try 70 years ago.

[cynwoody]

Had. Couldn't pre-emptively pardon himself. His AG would not pursued an indictment. But any Democratic administration would have.

Where is it written that the pardon must follow the indictment? As I recall, Gerry Ford didn't wait around for Milhous to get indicted.

[zeestephen]

What if Bush confessed to war crimes while still in office, documented everything, then pardoned himself on his last day as president?

[thackney]

Again, I appreciate the real numbers. But back in July, we were still looking at $100 oil. The significant price drop has come later.

From late October: Libya now pumps at least 800,000 barrels a day, four times more than five months ago, when Thinni's government managed to end a rebel blockade of oil ports in the east. http://www.reuters.com/article/2014/10/23/us-libya-oil-idUSKCN0IC18520141023

Also impacting prices are the strength of the dollar.

And it is some falling demand, along with speculation of how far that demand might drop before world production falls.

It is not just one driving force. Saudi, along with other other contribute.

[thackney]

Most of ISIS wells are in Iraq, and some in Syria.

I read the production in that area is down to 20% of what it was before their presence. Wells are not magic machines. It does take some effort to maintain. At the same time, their sales appear to be at prices 25~50% of the market rate. Their buyers don't take the risk of dealing with them without their own benefit.

If the market prices fall, so are their prices as well, and to a far lower rate.

[thackney]

One of them said that financing for new wells in North America would completely stop if the price of oil goes below $67 per barrel.

I do not believe all drilling would stop at that price. But it would push away the hedge funds and other "outside" money that was investing into shale fields.

For actual oil companies, they will have to decide how long they think prices will stay that low. And the ones that did not borrow too much money are better set to buy some fire-sale assets and keep drilling at a slower pace.

[zeestephen]

By “financing” I mean direct loans for the purpose of drilling.

I’d be surprised if many hedge funds are in that business, although I’m sure many do make loans in exchange for an equity position.

Bottom line - no financial institution is going to make loans on a product that the owner can’t sell for a profit.