Now that oil prices have rebounded to $50 per barrel, will U.S. shale drillers turn the taps back on?
That is the million dollar question that the oil markets still do not have a clear answer on. Last year, when oil prices rebounded from $44 per barrel in March to $60 in June, the rig count leveled off. Some drillers even redeployed some rigs, stepping up drilling ahead of what they believed would be a swift rebound in prices.
The renewed drilling spooked the markets and crude plunged again, and since August of last year, the rig count has been falling, shedding another 400 to 500 rigs in only nine months.
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Now that crude prices have firmed up at around $50 per barrel, will the rig count rebound again? Will prices build on their momentum, and move closer to $60 per barrel? And, perhaps most importantly, can drillers make money at today’s prices? Related: Why Cheap Shale Gas Will End Soon
There are a multitude of variables that will determine the how fast drilling starts to pick up. But one of the most important metrics to look at is the breakeven cost of drilling in some key U.S. shale regions. According to a report from KLR Group, and reported on by Oil & Gas 360, many of the most prolific shale basins in the U.S. are still in the red at today’s prices.
For example, the Eagle Ford West breakeven price sits at $59 per barrel and the Eagle Ford East has a breakeven of $52 per barrel. Meanwhile, the Bakken, another major source of U.S. oil production at over 1 million barrels per day, has a breakeven price at a whopping $67 per barrel, meaning many drillers in North Dakota are still losing money.
Even some of the best parts of the Permian Basin in West Texas have higher breakeven prices than many believe. The Midland Basin, for instance, which offers some of the best economics in U.S. shale oil production, has a breakeven price of $51 per barrel.
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Image courtesy: Oil and Gas 360
The story is similar for natural gas production – breakeven prices could be much higher than is popularly cited in the media. For example, many parts of the Marcellus Shale, which accounts for the bulk of U.S. shale gas production, has breakeven prices at around $3.50 per million Btu (MMBtu), vastly higher than today’s Henry Hub spot prices of less than $2/MMBtu. Related: Clinton Chasing Votes With Fracking U-Turn
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Image courtesy: Oil and Gas 360
In short, the KLR study finds that most oil and gas regions need much higher prices to provide companies with a financial return. In order for companies to generate a 10 percent unleveraged rate of return, the Midland Basin and the Eagle Ford East will need oil prices in the range of $80 to $85 per barrel. And those are some of the best places to drill. The price needed for a 10 percent unleveraged rate of return only goes up from there. The SCOOP/STACK plays in Oklahoma require oil prices near $100 per barrel.
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Many individual companies have reported lower breakeven prices than these, but by and large, the KLR Group report shows that shale drilling economics may not be as rosy as some believe. Some might question the validity of this data, and to be sure breakeven estimates run the gamut. But, if the industry could make money in U.S. shale at $40 or $30 then there would not be more than 70 shale companies that have declared bankruptcy. If breakeven prices were that low, the rig count would not have collapsed by 75 percent in 18 months, nor would U.S. oil production have ground to a halt and then plummeted by nearly 1 million barrels per day since last year.
Clearly, prices are substantially too low for many drillers to make money. As a result, despite predictions from the EIA and others that oil prices could stay low for much longer – the EIA expects WTI to average $50 in 2017 – prices are still unsustainably low. If drillers can’t make money at $50 per barrel, supply will continue to fall, triggering a rise in prices. In short, prices must rise.
Companies began drilling last year as oil prices hit $60 per barrel on the expectation that further prices gains were in the offing. But many drillers may not be so willing to jump back into the fray this time around, at least at first, if only because there is a lot less certainty over the solidity of the rebound. That will lead to further declines in U.S. supply, which, again, will push prices much higher than $50 per barrel.
By Nick Cunningham of Oilprice.com
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If the analysis includes absolutely all costs to be incurred in the full cycle of an E&P business, the pretended consecuence that current price of US$ 50 per barrel won´t incite US shale producers to drill is wrong, for the following reasons:
the decision to drill is always taken as a "marginal decision", that is, you need to consider the discounted cash flow of the additional capital investment, revenues and expenses to be produced by each additional well. In order to make that decision, you don´t consider already sunk costs, such as acreage cost, seismic, fixed G&A expenses, etc.
This means that, even when a company need a prices of, for example, US$ 70 per barrel in order to "break even" on a corporate basis, this company could decide to drill, if the additional wells to be brought online can generate a positive discounted cash flow on the own.
Of course, in the long run, a company that can not cover all its costs and generate a reasonable rate of return for its stockholders won´t survive. But in the short term, any well that can generate a positive return on a marginal basis should be drilled from an economic point of view.
This is the reason why it´s necessary to make clear what costs were included in the analysis of the "break even"price for the differente plays.
This is faulty logic. It presupposes that there is durable demand for oil priced over $50/b, that there are not other suppliers below $50/b, and that there are not other alternatives to oil priced over $50/b.
Even at $50/b oil is priced at a very high energy premium to natural gas and coal below $2/mmbtu. Moreover, wind and solar are sufficiently competitive with gas and coal to keep fuel below $2/mmbtu. This means in every market where natural gas and oil compete, oil will keep losing market share. Even in transportation, an LNG glut becomes an opportunity for truckers and shippers to switch from diesel to LNG.
There are very few markets willing to pay more than 3X the price per Btu for oil sourced products over the price of energy. If US drillers cannot deliver below price competitive supply below $50/b, they will simply go out of business. Sure, in the short run, consumers can be induced to pay a high premium for oil, but in the longer run, they will switch to lower cost energy. That is why there is no durable demand over $50/b.
The price of oil is no longer the price of energy. The price of natural gas is a much better proxy for the price of energy. Oil is a premium class of products compared to cost of clean heat. The world does not need to keep paying a high premium for oil.