The IEA’s forecast that U.S. shale will dominate the oil market over the next three years because of skyrocketing shale production made global headlines on Monday, but the conclusions should not be taken as gospel. The industry could run into a series of headwinds that could slow production growth, starting with demands from investors to see higher returns.
“Last year, it was drill, baby, drill,” John Hess, CEO Hess Corp., told the audience at the CERAWeek Conference in Houston on Monday. “This year, it's show me the money.” He argued that shale drillers are feeling pressure from investors to post profits, which could slow the pace of development.
Yet, so far, while the newfound and highly-touted capital discipline mantra is being talked about quite a lot, it has not translated into a slower pace of drilling. The U.S. is breaking production records every week, and output is growing at a blistering rate.
However, that doesn’t mean that the growth rate will continue, or that U.S. shale will add nearly 4 million barrels per day over the next five years, as the IEA predicts.
There are a variety of bottlenecks that could constrain output and slow growth. For instance, with so much drilling concentrated in a relatively small area in West Texas, there are shortages of oilfield services, fracking crews, labor, and frac sand.
Last year, the backlog of drilled but uncompleted wells (DUCs) mushroomed as shale E&Ps drilled more wells than they could complete. The completion rate is now on the upswing, up 79 percent from a year ago, according to Reuters. But the number of DUCs is also rising, illustrating a persistent bottleneck in completion services. There are other holdups, including takeaway capacity for natural gas and limits on gas flaring, which could hamper oil production. Related: What’s Driving Oil Prices Back Up?
All of these constraints could lead to cost inflation, as well as slower-than-expected production growth. The most prominent warning on this front could come from Mark Papa, the former chief executive at EOG Resources, a well-known Texas shale driller. Now heading up a smaller shale company, Centennial Resource Development Inc., Papa told the WSJ that the aggressive oil production forecasts from the likes of the IEA and EIA are likely overstating the potential from U.S. shale. “The oil market is in a state of misdirection now,” he said in an interview with the Wall Street Journal. “Someone needs to speak out.”
He cited the strain on frac sand and oilfield services, and also pointed out that some of the most attractive areas to drill in North Dakota and South Texas have already been picked over. That will force drillers out of the most prized locations, which could lead to higher costs and/or lower output. Ultimately, the U.S. might not live up to the hype in the years ahead.
The IEA, despite its bullish forecast on U.S. oil output, conceded that costs could rise. “After years of remarkable improvements in wellhead break-even prices for the main plays, 2017 saw a slight increase and it is widely believed that they will rise further in 2018,” the IEA said in its Oil 2018 report. “US wages and service costs are already rising and latest inflation figures suggest a broader upward pressure on input prices. Moreover, recent data suggest that improvements in drilling efficiency and well productivity have stalled or even decreased in some areas.”
The agency says that U.S. shale output will likely plateau by 2023, and might even “fall away” absent higher prices or significant breakthroughs in drilling technology. Related: China Is Single-Handedly Solving The Gas Glut
Meanwhile, shale output is only about 5 percent of global oil production, and while it will make up the majority of new supply for the next few years, it won’t be able to carry the load beyond the early 2020s.
Hess pointed out that the IEA estimates that the oil market needs roughly $540 billion in annual oil investments just for supply to keep pace with demand over the long-term. The problem is that the price downturn that began in 2014 has hollowed out spending, with expenditures only modestly rebounding in the years since. In 2016, the industry spent $380 billion, which rose slightly to $400 billion in 2017. In 2018, another modest bump will take spending to $420 billion – still far short of what will be needed to satisfy demand growth.
Still, as the IEA notes, shale output is expected to grow so much so fast that the oil market might not feel the pinch for a few years. In that sense, shale growth could be crowding out investment elsewhere in the short run, which could lead to a shortfall in supply in the 2020s. That problem becomes even more problematic because spare capacity will be extremely thin, especially if OPEC returns to higher levels of production.
“We're not investing enough, and the three years of underinvestment are going to start being seen in the next several years,” Hess said at CERAWeek, according to the Houston Chronicle. “The only way to encourage more investment is a higher price.”
By Nick Cunningham of Oilprice.com
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