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American shale firms are now the oil market’s swing producers

BIG companies making big bets on big oilfields, while a cartel of oil-producing states fixed the price to keep itself rich and others, including the oil majors, profitable. That, in caricature, was how the oil industry once ran.

That model now seems broken. On May 13th the International Energy Agency, representing the main oil-consuming countries, said a global oil glut was building, as Saudi Arabia pumped oil frantically in a continuing battle for market share with American shale-oil producers. The shale firms have proved a lot more resilient, and a lot more productive, than the Saudis and other members of OPEC, the producers’ cartel, had expected. Last November, with prices already slipping, OPEC’s members stopped trying to agree production quotas among themselves, sending crude tumbling further. Their hope was that this would force rival producers, especially in the American shale beds, to slash investment. As supply tightened drastically, the oil price would rebound.

This has not happened. Prices have staged only a partial recovery: West Texas Intermediate (WTI), one of the main benchmark prices for crude, was just above $100 a year ago and hit a low of around $44 in March; it had recovered to just $60 by the middle of this week. If the glut persists, the price is likely to slip back. As OPEC oil ministers prepare for a meeting in Vienna next month, a draft paper leaked to the Wall Street Journal said that even in its most optimistic scenario, the price will not exceed $76 a barrel until after 2025. It also considered a scenario in which it fell below $40. OPEC denied that the draft existed, but the conclusions ring true: the chances of a return to triple-digit crude prices look slim.

The big oil multinationals, such as BP, Chevron, ExxonMobil, Shell and Total, have responded to the weaker oil price by cost-cutting, and postponing and cancelling some of their exploration projects (although Shell this week got a provisional go-ahead to restart a $6 billion project in the Arctic, troubled by delays and accidents). However, the output of the shale firms has proved surprisingly robust, even though they have cut their number of rigs significantly since the peak last October (see chart).

One reason for this is canny hedging by some shale producers, which means they are in effect getting paid above the current market price. But many unhedged producers have also continued to pump oil, since the market price is still above the marginal cost of producing another barrel, even if it doesn’t cover the upfront costs of drilling the well. Most important of all, their productivity has continued to improve in leaps and bounds. Wells that used to take 35 days to complete now take 17, says Daniel Yergin of IHS, a research firm. The amount of oil produced per dollar invested will rise by 65% this year, he says. Better seismic data, improvements to the fracking liquids pumped into wells and more intensive deployment of rigs are all helping.

In all, IHS reckons that 80% of the new capacity this year will be profitable with WTI at $50-$69 a barrel.

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