Crude Oil Market Adjustment Is About More Than US Shale Production

Crude Oil Market Adjustment Is About More Than US Shale Production

$OIL, $USO, $BHI

Shale is more expensive to produce than Crued Oil from the giant conventional fields of the Middle East but cheaper than deepwater mega-projects

US Shale Oil production amounted to just 5-M BPD at the end of Y 2014, less than 6% of world production and consumption.

Despite the shale sector’s small market share, it has disrupted the entire Oil industry because it emerged in the middle of the cost curve and has accounted for more than 50% of the increase in global supplies since Y 2010.

Between Y’s2010 and 2014, Shale output rose by 4-M BPD accounting for more than 50% of the 7-M BPD increase in global liquids production over the same frame, according to the US Energy Information Administration (EIA).

Shale is more expensive to produce than Crude Oil from the giant conventional fields of the Middle East but cheaper than deepwater mega-projects and competes directly against the North Sea and Canada’s Oil Sands.

Shale’s competitiveness on price and fast growth scrambled the plans for every other participant in the Oil industry.

Mega-projects developed by the major international companies must now be bench marked at prices of just 70 or even 50 bbl rather than the 80-100 which underpinned planning assumptions until a year ago.

Middle East exporters, accustomed to spending profits of more than 50 bbl on social programs, must now adjust to smaller revenues.

And high-cost producers in the North Sea, Alberta, Latin America, Africa and frontier exploration areas are struggling to survive.

Experts originally put the marginal cost of Oil from the shale plays in North Dakota and Texas at 70 bbl, but efficiency gains have cut breakeven prices to 60 or even 50 and they could be as low as 40 or even 30 in the best producing areas.

Shale Oil can be called a revolution comparable to the introduction of rotary drilling at the turn of the 20th Century and the opening of huge conventional reservoirs in the Middle East in the 1950’s and 1960’s.

But Shale’s disruptive impact should not obscure the fact it still meets only 5% of global demand.

Too much analysis still focuses exclusively on shale and OPEC, ignoring the effect of lower prices on non-OPEC non-Shale output, which accounts for more than 50% of global liquids production.

The market has become obsessed with breakeven rates for the very best parts of the Bakken, Eagle Ford and Permian Basin Shale plays, as if those were all that mattered for the price of Oil in the short and medium term.

But the medium-term outlook for the Crude Oil market depends on continued growth in conventional production and applying the techniques pioneered in North Dakota and Texas to other plays in the United States and to countries such as Argentina, Russia and China, where costs are higher.

According to most forecasters, global Crude Oil demand is growing at an annual rate of 1.5-M BPD or more, which must be met from somewhere.

US Oil production has held up surprisingly well in the face of the dive in prices, but is set to be lower at the end of both Y’s 2015 and 2016 than at the end of Y 2014, according to the EIA.

After 3 years in which US production grew on average by more than 1-M BPD annually, US output is expected to expand by just 650,000 BPD on average in Y 2015 and then shrink by 400,000 BPD in Y 2016.

With Shale Oil stalling, increased demand will have to be met by OPEC and non-OPEC non-Shale producers.

Saudi Arabia and its close allies in OPEC (Organization of the Petroleum Exporting Countries) are banking on this to rebalance the Oil market and absorb an increase in Iran’s exports in Y 2016.

The Saudi’s strategy is not as far-fetched as it may seem.

While Shale producers may be able to cope with prices of 40 or 50 bbl by high-grading and focusing on the best areas of existing plays, the industry will struggle to grow  unless prices rise.

Breakevens in the core counties of the Bakken might be as low as 30 or 40, according to North Dakota state regulators, but outlying areas need 60 or more to cover their costs and provide acceptable returns.

The same is true for the Eagle Ford, Permian Basin and Niobrara Shales in Texas and the Southwest: it may be possible to sustain production by retrenching to the core but substantial growth will likely require higher prices to enable more marginal areas to be developed.

Outside the United States and OPEC, sustaining and growing production requires substantial investment to offset decline rates from existing wells and add extra output.

But non-OPEC producers are slashing capital expenditure. With Crude Oil prices hitting new lows, non-OPEC non-shale producers have embarked on another round of layoffs and cost-cutting.

The number of rigs drilling for Crude Oil outside North America and OPEC has fallen by 22% since July 2014, according to oilfield services company Baker Hughes (NYSE:BHI).

Further reductions in the rig count seem inevitable in coming months as existing drilling programs are completed and exploration and production budgets cut.

Many analysts assume either OPEC or the Shale producers will have to cut production substantially to realign the market.

It is more likely OPEC production will continue to grow, Shale stabilizes or shrinks slightly, and the rest of the adjustment is borne by a substantial slowdown in conventional non-OPEC output, coupled with continued growth in demand.

Have a terrific week.

HeffX-LTN

Paul Ebeling

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