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Sub-$50 Oil Could Kill Shale

Oil prices are at their highest levels in months on the back of strong demand and some key supply outages around the world. But the next price movements are unclear, as is the response from U.S. shale.

As the International Energy Agency (IEA) noted last week, global oil supply fell in August by about 720,000 bpd—a large contraction after months of sizable gains. Much of that is probably temporary, particularly in the U.S. and Libya, two countries that saw unexpected outages. But the demand story is arguably more important: the IEA upgraded its demand forecast for the year, as consumption has surprised on the upside.

WTI is now back in the vicinity of $50 per barrel, while Brent topped $55 per barrel in recent days—its highest level since the beginning of 2017. But that doesn’t mean that the price gains will continue. There are a few reasons to be skeptical that the momentum will carry crude prices higher than current levels.

Related: Does Russia Really Need The OPEC Deal?

CNBC notes that over the past three years, whenever WTI rose above $50 per barrel, a ton of pressure quickly derailed the upward trend. CNBC found that WTI exceeded $50 per barrel 18 times since December 2014, but after it crossed that threshold, the next week’s price movement was positive only 28 percent of the time. Or, put another way, over the past three years, whenever WTI jumped above $50 per barrel, three out of four times the price dropped a week later. Meanwhile, The United States Short Oil Fund, an exchange-traded fund that shorts WTI, was positive 67 percent of the time in the week following a $50 price breach.

In other words, major investors quickly made bearish bets whenever it seemed that WTI was getting too high, and in many cases $50 per barrel was the threshold around which bullishness and bearishness pivoted.

That makes sense because $50 also seems to be an important marker for the starting and stopping of U.S. shale. Drilling activity ramped up at the end of last year and earlier this year after the initial OPEC agreement pushed prices above $50. But drilling activity came to a screeching halt and the rig count flat-lined a few months ago when WTI sank to the low $40s.

Now, a few months after shale drillers dialed back their ambitions, the oil market seems much improved and WTI is back at $50. While breakeven prices vary widely from driller to driller, $50 per barrel appears to be a rough rule of thumb for an industry-wide average breakeven price. While imprecise, the past year or so has seen shale ramp up and down depending on which side of $50 per barrel WTI finds itself on.

The next steps are important but also uncertain. If WTI does post some gains, it seems reasonable to expect U.S. shale companies to accelerate drilling activity.

But even if drillers feel confident with $50 oil, not everyone thinks the industry is on sound financial footing. Jim Chanos, a short-seller with Kynikos Associates, spoke at a CNBC investor’s conference last week and laid out his case for shorting the shale industry. “In our view, people have been looking at this industry through the rose-colored glasses of Wall Street,” he said. “And this is the inherent problem with the North American shale business.”

Chanos argued that shale drillers are using up all of their revenues to reinvest in capex, leaving them with little to nothing left over to pay off debt. Because companies have to keep drilling in order to maintain production, they find themselves stuck on a spending treadmill. “The way to think about it is that unlike other businesses, your assets literally get burned up,” he stated. One of the companies Chanos singled out during his speech: Continental Resources, the North Dakota and Oklahoma shale driller. Related: Supermajors Prepare For A Permian Bidding War

Continental’s CEO Harold Hamm was testy in a follow-up CNBC interview, responding to Chanos’ claims. "Well, first of all, I can say almost, who is this guy? A short-seller,” Hamm declared. He also suggested that Chanos might be getting burned as oil prices rise, and he is simply trying to talk down oil prices.

The exchange is fitting because Hamm has previously said that $50 per barrel was the price needed to keep shale sustainable. If WTI stays at current levels or moves up from here, we’ll find out if he is right over the next few quarters.

By Nick Cunningham, Oilprice.com

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  • Kr55 on September 17 2017 said:
    It's more complicated than just a dollar figure. For all intents and purposes, the Bakken and Eagle Ford are tapped out after 3 years of drilling sweat spots just to keep companies alive. Some companies in those plays still have good inventory, but their growth will be offset by declines elsewhere in the plays.

    For the Permian, there is a huge range of break evens and quality of remaining inventory as well. Not only are many Permian companies looking at the end of their tier 1 inventory, but others are finding out many DUC's they drilled may be near useless because fracking them will destroy production from other wells too close by. Plus, pressure issues in general are becoming a topic in the Permian as many wells are turning gassy far earlier than expected. This is all adding up to huge disappointments in the shale oil industry in he USA, backed up by 5 months of flatlining production in the USA as well even though many producers bragged about their 55+ hedges to fund that period.
  • mkschro on September 17 2017 said:
    Nice title, but truth be told, given the way shale companies are now capitalizing costs, using all sorts of special accounting practices, recklessly inflating BOEs using a 6/1 GOR conversion, and finally exploiting presently ultra-low service company rates, even Sub-$65 Oil Could Still Kill Shale. Wall Street investors would do well to investigate what Jim Chanos is saying, because that 20% drop after Q2 earnings reviews is only the first shoe to drop, more are coming.
  • Henry on September 18 2017 said:
    Looks like the the title of the article kind of went past the commentators. The point is after we see $50 oil then oil usually plummets. Let be clear......at $50 oil shale companies are raking in the dough and offshore is continuing its slow death.
  • zorro6204 on September 18 2017 said:
    "Drilling activity ramped up at the end of last year and earlier this year after the initial OPEC agreement pushed prices above $50"

    Slight corrections, the rig count started to rise in earnest by early September, and the bottom came earlier in the summer. WTI threatened the $50 level a few times in the latter half of 2016, but didn't average consistently higher until early December. In fact, the lowest WTI fell on a weekly average basis (EIA) this year was $43.09 in late June, but it was down in that range a couple times during the rig count runup in late 2016.

    I think what happened is that prices held up high enough in the mid to high $40's to allow some optimism to return that prices wouldn't absolutely pancake again, down into the $30's. The failure of prices to hold over $50 and the plunge down into the $40's appears to have been received as a warning shot not to over-indulge in spending.

    What level prices actually need to be to keep production at least equal to demand is not known yet. A lot of experts think it's $50, but since when have there been any prophets in this pursuit? The field is littered with the corpses of bad calls, like Cramer saying WTI was about to "fall off a cliff" recently (it didn't, it rose). We'll only know the true minimum price in the rear view mirror.
  • Disgruntled on September 18 2017 said:
    I maintain we'll know the true, fair price for oil, or any other commodity, when we limit the contracts for said commodity to the actual physical requirement for that day. In the case of oil, that would presently be somewhere around 98 million barrels per day worth of contracts, for October/November 2017 (WORLDWIDE, ALL GLOBAL STOCK EXCHANGES!). Then, if you want to buy some oil for the future, the amount would be revised upwards for that foreseeable date, e.g., August 2021. Since oil demand is a fairly consistently rising number, percentage-wise, that figure could be estimated fairly closely. Let's see what happens to the price of oil when hundreds of millions of imaginary barrels (of supply) are taken out of the equation.
  • Mike on September 18 2017 said:
    Shale boom drives down cost, now $50 oil will kill shale? More like $50 oil needs shale. They have the cart in front of the horse.
  • Crazy Uncle on September 18 2017 said:
    Henry, "raking" in the dough? Which shale companies are you referring to? Do you think they will make enough money to pay back the massive amount of debt they have coming due? It's been a great scam. Good for management, bankers, royalty owners, and consumers. Let's be honest the world is awash with oil and hardly any of it is economic!

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