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Will OPEC Use This Strategy To Defeat U.S. Shale?

Oil Rig Sunset

OPEC’s strategy in the past have been to maneuver its oil production to bring about market stability. However penetration of U.S. shale oil forced them to alter their strategy in favor of market share even at the cost of lower oil prices. This paper intended to carry out some vigorous quantitative analysis and assess/forecast the possible implications on shale oil production under alternative oil price scenarios. What if, oil prices are allowed to gradually increase to December 2020 (Reference case) and what if oil prices remains weak and decline over the forecast period (Low case)? Based on assessment some policy conclusion may be drawn.

Mastering technology - constantly lowering break-even cost

The shale oil boom that started with stable oil prices of over $100/bbl continued several months even after collapsing of oil prices. Higher oil prices provided excellent opportunity for the shale oil industry to learn and mature. In the process companies were able to increase average productivity per well by multi-fracturing, horizontal drilling, including well configuration and concentrating towards the most productive areas of the Basin. For example, oil productivity per rig for the Bakken increased from 112 b/d in January 2007 to 746 b/d in March 2016 – over 6.6 fold increase. There is also marked improvements in Estimated Ultimate Recovery (EURs) and in some of the basins it reached 50 to 60 percent in 2015/16. Related: Nigerian Outages Drag Total OPEC Production Down In May

The significant increase in productivity allows the industry to produce more by employing less capital resources that resulted in a marked improvement in break-even cost. Consequently, industry was successfully countering the lower oil price environment.

Due to this learning curve, some of the basins’ breakeven costs dropped below $30/bbl, which motivated a number of companies to continue to produce despite the weaker oil price environment. One should be cautious while analyzing breakeven costs; they vary from basin to basin or even within formations and between companies. For example, in the Eagle Ford formation, the average well can be profitable with U.S. benchmark crude at $22.52 a barrel, $4 below the lowest level this year. However, if you drive 200 miles southwest to Dimmit County, drillers need a breakeven price of $58/bbl.

U.S. shale oil industry became history

The general expectations were that the U.S. shale oil industry will become history if lower oil prices persist over an extended period of time. Contrary to the expectations, the shale oil industry not only survived, but remained strong. Shale oil production increased from 1.22 million barrels per day (MMBD) in January 2007 peaking 5.62 MMBD in April 2015, and then began to decline. By March 2016, it dropped down to 5.06 MMBD – a production loss of 0.56 MMBD.

In early 2015 based on monthly data January 2007 to February 2015, the author developed an econometric model for each of the U.S. seven shale oil basins which was published as “Plunging oil prices – US tight oil boom or burst?” in European Energy Review (EER). The paper concluded that various shale basins responded differently with the changes in oil prices. Generally, there was no response to changes in oil prices during the short-term. Over the longer-term, the price response strengthened but still remained weak.

Methodology and data

We have used monthly data for U.S. seven shale basins (Bakken, Eagle Ford, Haynesville, Marcellus, Niobrara, Permian, and Utica) from January 2007 to March 2016. Figure-1 illustrates the oil price actual monthly West Texas Intermediary (WTI) data (January 2007 to March 2016) and forecast prices till December 2020 under alternative scenarios. The oil production for each basin is compared to monthly average WTI prices from January 2007 to March 2016. We have run several polynomial distribution lag models (Almon) and (Koyack) with and without constants and also used an autoregressive/moving average scheme to correct autocorrelation problems wherever it is required. The best estimated model for each basin was selected and then re-run to forecast respective basins’ shale oil production under alternative price scenarios.

Shale oil production forecast alternative scenarios

The actual production levels from March 2016 and the forecasted production under alternative scenarios is tabulated in Table-1, and also graphically presented in Figures-2 to 8. During March 2016, U.S. shale oil production from the given seven basins increased from 1.22 MMBD in January 2007 to 5.06 MMBD in March 2016. Eighty-eight percent of U.S. shale oil production has been associated with three major basins – Permian (40%), Eagle Ford (26%) and Bakken (22%). The rest of the production is associated with other four basins.

Based on our best estimated models U.S. shale oil production under the reference case is expected to gradually increase in response to favorable oil prices, with a forecasted prices of $78/bbl in December 2020. Under reference case U.S. shale oil production from the Bakken, Eagle Ford, Niobrara, Permian and Utica responded with the increase in oil prices, surpassing their respective peaks to date. Marcellus production responded after a lag of 10-12 months but failed to recover over March 2016 production levels. Haynesville response was quite insensitive and failed to arrest its declining trend. By December 2020, total U.S. shale oil production from the given seven basins increase to 6.79 MMBD – an increase of 34 percent compared to March 2016. In contrast, under low oil price scenarios, shale oil production declines in all the basins and by December 2020 declines to 3.03 MMBD – a decline of 67 percent compared to March 2016.


The analysis concluded that U.S. shale oil industry is insensitive to changes in oil prices in the short-term, but strengthen in the longer term. When oil prices increase, shale oil production increases and generally recover the lost share in production but also surpass their respective peaks. However, under persistent lower oil price regime U.S. shale oil industry loses 67 percent of their production as compared to March 2016. Related: What’s Really Behind This Oil Price Rally 

This analysis could provide some critical answers to OPEC, offering some clues on how the cartel could defend its market share. One strategy may be to flip flop oil production in order to navigate increases/decreases in oil prices (although this may run counter to their fundamental policy). For example, OPEC members could sincerely freeze oil production or even decrease production and allow oil prices to gradually increase between $50 to $78/bbl for 5 to 8 months (lag to respond by shale oil industry) and then increase their production (for 4 to 5 months) to lower oil prices back down to $50/bbl to dampen the revival of shale oil production. This “flip flop” strategy of production variation will allow OPEC to fetch an average of higher oil prices compared to their strategy of only defending market share, while at the same time also keep the shale oil revival in check.

(Click to enlarge)

(Click to enlarge)

By Salman Ghouri for Oilprice.com

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  • Jan on June 04 2016 said:
    The "flip flop" strategy won't work because American shalers will hedge at $80.

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