Can the U.S. shale boom continue if WTI stays mired below $50 per barrel?
Much has been made about the dramatic cost reductions that shale drillers have implemented over the past few years, with impressive breakeven prices that should ensure the drilling frenzy continues no matter where oil prices go. On earnings calls with investors and analysts, shale executives repeatedly trumpeted extremely low breakeven prices.
However, those figures are at times cherry-picked or otherwise misleading. They fail to include the cost of land acquisition and other costs, or they simply reflect cost structures in only the very best acreage.
The sudden meltdown in prices – oil fell nearly 8 percent on Tuesday – could put renewed scrutiny on the point at which many shale wells breakeven.
The problem for a lot of companies is that they are not necessarily earning the full WTI price. Oil in West Texas in the Permian Basin continues to trade at a steep discount relative to WTI, even as the differential has narrowed in recent months. With WTI at roughly $47 or $48 per barrel, oil based in Midland is trading below $40 per barrel, the lowest point in more than two years, according to Bloomberg.
Bloomberg NEF data provides more clues into the complex “breakeven” debate. Wells located in the Spraberry (within the Permian basin) can breakeven when prices trade between $32 and $47 per barrel. Digging deeper, Bloomberg NEF notes that some of the best wells can break even in the low $30s, but the worst quartile of wells breakeven at an average of $65.54 per barrel.
In other words, a large portion of wells in the Permian – which, to be clear, is often held up as the best shale basin in the world – is currently unprofitable, given WTI priced in the high-$40s per barrel. The problem is even worse for areas outside of the Permian, where breakevens are on average much higher. Arguably only the very best wells in the Bakken, the Eagle Ford and the Niobrara are making money right now.
That puts the heady production figures from the EIA for 2019 into doubt. The agency expects the U.S. to grow production by 1.2 million barrels per day (mb/d) in 2019, another very large annual increase. However, that growth is predicated on higher oil prices. “If WTI remains around current levels (~$50/bbl), US growth should start to slow,” Morgan Stanley analysts wrote in a recent note.
There are some mitigating circumstances that could shield shale producers from the worst. Shale E&Ps routinely hedge their production for the year ahead. Just months ago, some of those hedges looked like a bad bet – producers had locked in prices in the $50s or so for much of 2018, even as oil prices over the summer traded much higher than that. For instance, Anadarko Petroleum said it missed out on $298 million in revenue because it locked itself into hedges at price levels lower than the prevailing spot price. Related: The Race Is On: Big Oil Rushes To Supply The 1 Billion Disconnected
On the other hand, for those that locked in sales for 2019 production in, say, the $60s per barrel, might feel pretty good about that right about now. To the extent a shale company has already secured hedging for 2019, they may not alter their drilling plans for next year all that much.
Unfortunately for many, though, is the fact that the industry has held off on some hedging for next year, assuming prices could climb even higher. “Producers have a lower proportion of their next 12 months oil production hedged for this time of year relative to the last few years,” Morgan Stanley analysts said in a note.
Another reason why supply might not actually be severely curtailed despite low prices is that shale companies could simply keep up their pace of drilling in 2019 and take on more debt, just as they did for so many years. The assumed production growth rate might not change all that much, even as balance sheets deteriorate.
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Standard Chartered provides some more insight, with a look at the rate of well completions: “We estimate that 374 completions per month are currently required in the Permian to offset declines. The number of Permian completions in November was 65 higher than the breakeven completion rate at 439,” the investment bank wrote in a note. “The number of completions would then have to fall about 17% before Permian output stopped growing. While we expect a slowdown in completions if the price of WTI in Midland, Texas were to remain close to the current USD 42/bbl, we would not expect a fall in completions large enough to halt net growth.”
Finally, sub-$50 oil might not be a huge problem if benchmark prices rebound in the relatively near future. Saudi oil minister Khalid al-Falih tried to reassure the market this week that we will not see a repeat of the 2014-2016 meltdown. “We remain focused on fundamentals, I can tell you we will achieve balance between supply and demand in 2019,” he told reporters. There will be enormous pressure on OPEC+ to extend the latest production cuts through the end of 2019.
But the longer low prices stick around, the more significant the impact will be on production. “If strip prices remain subdued into early 2019 at around $50 WTI, we would expect budgets to be set at levels that reduce the trend rate of growth, all else equal, which we would expect to become more noticeable by 2020,” Morgan Stanley concluded.
By Nick Cunningham of Oilprice.com
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