This Is Why A Serious Decline In U.S Shale Plays Is Not Far Away

The plunge in oil prices last year led many to say that a decline in U.S. oil production wouldn't be far behind. This was because almost all the growth in U.S. production in recent years had come from high-cost tight oil deposits which could not be profitable at these new lower oil prices. These wells were also known to have production declines that averaged 40 percent per year. Overall U.S. production, however, confounded the conventional logic and continued to rise--until early June when it stalled and then dropped slightly.

Anyone who understood that U.S. drillers in shale plays had large inventories of drilled, but not yet completed wells, knew that production would probably rise for some time into 2015--even as the number of rigs operating plummeted.

Shale drillers who are in debt--and most of the independents are heavily in debt--simply must get some revenue out of wells already drilled to maintain interest payments. Some oil production even at these low prices is better than none. Only large international oil companies--who don't have huge debt loads related to their tight oil wells--have the luxury of waiting for higher prices before completing those wells. Related: The Four Noble Truths Of Energy Investing

The drop in overall U.S. oil production (defined as crude including lease condensate) is based on estimates made by the U.S. Energy Information Administration (EIA). Still months away are revised numbers based on more complete data. But, the EIA had already said that it expects U.S. production to decline in the second half of this year.

What this first sighting of a decline suggests is that glowing analyses of how much costs have come down for tight oil drillers and how much more efficient the drillers have become with their rigs are off the mark. It was inevitable that oil service companies would be forced to discount their services to tight oil drillers in the wake of the price and drilling bust or simply go without work. And, it makes sense that the most inefficient uses of drilling rigs would be halted. Related: Energy Stocks: Undervalued Or Value-Trap?

But the idea that these changes would somehow allow tight oil drillers to continue without missing a beat were always promoted by an industry sinking into a mire of over indebtedness in the face of lower prices. In order to maintain the flow of capital to the industry--which has consistently spent more cash than it generates--the illusion of profitability had desperately to be maintained. A recent renewed slump in the oil price may finally pierce that illusion among investors.

As Iranian oil exports start to ramp up in the wake of an agreement on nuclear weapons--the Iranians aren't allowed to have any--and the resulting end of economic sanctions, the oil price is likely to fall further, putting even more pressure on U.S. domestic drillers. Related: Forget Media Hype. Oil Set To Rebound

OPEC, which has refused to reduce output in the face of slackening world oil demand growth, continues to say that others--such as U.S. tight oil drillers--will have to "balance the market," a euphemism for cutting production in order to push up prices.

It looks as if U.S. drillers may finally be doing just that. Who knew that 45 years after abandoning the role of the world's swing producers--that is, producers who adjust production up or down to maintain stable world oil prices--U.S. oil companies would be forced into that role again entirely against their will?

By Kurt Cobb

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