There is every reason to believe that the shale industry will emerge stronger from the current low-oil-price environment.
The low-oil-price environment that has prevailed in recent months has presented significant short-term challenges, including squeezed margins and collapsing activity levels, to producers of U.S. shale oil. We believe, however, that an extended period of low oil prices might actually help reset the industry, in terms of the characteristics and pace of its growth, for the better and place it on a more sustainable development path for the medium term. We see four reasons to believe that this could be the case.
First, the current level of oil prices means that, from the perspective of producers, it only makes economic sense to develop their highest-quality acreage. It also forces these companies to put a premium on efficiency in development, meaning the use of technically advanced, cost-effective approaches. (Technological advances in the shale arena have already led to sizable jumps in efficiency. As an example, while the number of rigs remained stable between 2011 and 2014, production of shale oil and gas tripled, rising from around 4 million barrels of oil equivalent per day to about 12 million barrels of oil equivalent a day.) The net effect of this will be that U.S. shale oil producers’ break-even costs will fall, making the companies’ earnings stability less vulnerable to the effects of future price cycles. This will be crucial for these businesses, we think, given what we consider the likelihood of an increasingly volatile oil-price environment—irrespective of the absolute level of oil prices—in the years ahead.
Second, the slump in rig activity—activity today is about 60% below last year’s peak—has cooled an overheated market in equipment and services, resetting development costs to lower, more sustainable levels. A similar “cost reset” is happening in all major oil basins world-wide. And while excessive cost and complexity are less of an issue for producers of U.S. shale oil than they are for, say, some developers working in challenging offshore basins (see my previous post on this topic, “Seven Steps Oil Companies Should Take Amid Falling Prices“), a parallel reset of costs in the U.S. means that the relatively advantaged cost position that most developers of U.S. shale oil enjoy versus their global competition will be secured.
Third, the availability of cheap debt for U.S. shale-oil developments is shrinking. (Listed U.S. exploration and production firms currently carry $260 billion in debt, double what they held in 2009.) The easy availability of low-cost financing was a key enabler of the rapid growth in U.S. shale-oil production in recent years—production that, in retrospect, was excessive relative to global demand growth once supply disruptions in Iraq and Libya abated. A more capital-constrained environment will favor more responsible and resilient developers that are oriented toward the long term.
Finally, the oil-price squeeze is driving operational efficiency and productivity to the top of all oil producers’ agendas, lowering development costs and increasing standards across the industry. Just as shale-gas producers have adopted a laserlike focus on efficiency in response to low gas prices in recent years, operators and service companies will apply the same focus to oil, improving well productivity, recovery, and economic break-even points.