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Arthur Berman

Arthur Berman

Arthur E. Berman is a petroleum geologist with 36 years of oil and gas industry experience. He is an expert on U.S. shale plays and…

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Why Breakeven Prices Are Plunging Across The Oil Industry

Oil Barrels

Shale companies have pushed breakeven oil prices below $40 per barrel—but so have major oil companies.

Analysts commonly portray cost reduction as something unique to the tight oil companies. Data from annual reports filed with the U.S. SEC (Securities and Exchange Commission) suggests otherwise.

(Click to enlarge)

Along with tight oil companies, ExxonMobil, Royal Dutch Shell, ConocoPhillips and ChevronTexaco all had 2016 breakeven prices below $40 per barrel (Figure 1).

Figure 1. Breakeven Prices for Majors and Tight Oil Companies Were All Less Than $40/Barrel in 2016. Source: Company 10-K and 20-F SEC filings and Labyrinth Consulting Services, Inc.

SEC 10-K and 20-F filings include the standardized measure, a projection of discounted (10 percent) future net cash flows from production of proved oil and gas reserves. By dividing the standardized measure by the volume of proven reserves, breakeven prices can be calculated by subtracting the future cash flow dollar-per-barrel amount from the SEC average price for the year.

How is it possible that ponderous major oil companies have similar breakeven prices to much smaller, innovative shale companies? Simple–costs have fallen for everyone since 2014 as oil field service companies competed for limited projects by working at a loss. Related: Wall St. Gears Up For The World’s Biggest Oil Trade

In fact, the oil and gas well drilling producer price index fell 45 percent between March 2014 and January 2017 (Figure 2). As I wrote in an earlier post, sharply lower breakeven prices are 10 percent technology and 90 percent industry bust.

(Click to enlarge)

Figure 2. The Cost of Drilling Oil and Gas Wells Fell 45 percent After The Oil-Price Collapse; Unconventional Plays Resulted In a 4-fold Increase in Drilling Costs. Source: U.S. Federal Reserve Bank, EIA and Labyrinth Consulting Services, Inc.

And for those who think that unconventional oil and gas are low-cost resources, those plays resulted in a 4-fold increase in the cost of drilling wells between March 2003 and March 2014. That’s why oil cost more than $90 per barrel for 4 years before the price collapse.

So much for technology solving all of our energy problems.

And when you hear about tight oil companies breaking even at $20 to $30 per barrel—that’s not what they told the SEC in filings made just a few weeks ago.

The Downside of Lower Breakeven Prices

The downside of lower breakeven oil prices is that companies make a lot less money in the future. Companies must write down reserves whose development costs are greater than their market value at lower oil prices. Figure 3 shows that future net cash flows were on average reduced by about two-thirds in 2016 compared with 2014.

(Click to enlarge) 

Figure 3. Lower Future Net Cash Flows Are The Downside of Lower Breakeven Oil Prices. Source: Company 10-K and 20-F Filings and Labyrinth Consulting Services, Inc.

Related: How U.S. LNG Transformed The Market

Companies are effectively high-grading their assets by writing down wells with poorer performance. Breakeven price is lower because only most profitable wells are included in the calculation. Plus, the burden of taxes in addition to property and equipment costs associated with written down assets are removed.

The key take-away is that 85 percent of lower breakeven prices were realized in 2015. Incremental improvement in 2016 was only 15 percent.

Advances in technology and efficiency are real but falling breakeven prices are no miracle and are not a shale company exclusive. Instead of celebrating lower breakeven oil prices, we should be lamenting lost future cash flows that an oil industry depression has wiped out.

By Art Berman for Oilprice.com

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  • Lee James on April 10 2017 said:
    Sounds like we become fixated on measures that are helpful, but have their limits. We watch the number of oil drilling rigs and crude flow like a hawk. Increasingly, we monitor current break-even crude prices. Are we motivated to track what the future holds in free cash flow? What is the year-to-year trend on the efficiency of crude extraction, and net cash flow?

    Sounds like we could sharpen our pencils. Investing in fossil fuel is becoming more challenging. Thank you for this latest article.
  • EdBCN on April 11 2017 said:
    All this means is that 'break even price' is a number that is easily manipulated by oil companies that are trying to maintain their stock prices. As prices go down, break even has to go down to keep valuations up.
  • Edmund Paulus on April 14 2017 said:
    I'm sorry Arthur but I believe you are displaying a number of logical fallacies in your analysis. Firstly, using the NPV of reserves as a proxy for breakeven is not a good assumption. The reason that the NPV per barrel of reserves was above 100 USD in 2014 and below 50 in 2016 was because of the price drop. The forward price curves used by IQREs dropped significantly as they hinge their future price curve to current prices. All of these companies took significant impairments, removing the high cost barrels from their books.

    As for the cost curves you're showing, shale makes up only ~5% of total production and less than 1% in 2010. The curve you present is for the entire industry's index. To say that 5% of the production drove the cost increase is illogical.

    I would agree that the entire industry - not only LTO - has seen significant cost reductions over the last 2 years but both are largely due to supply chain tightening. I would maintain that LTO has historically been more conducive to structural cost declines than the conventional world as we have seen drilling and completion efficiency gains - so if rig rates come back into equilibrium those gains should be retained. The industry as a whole will also see efficiency gains but it is more difficult to realize them.
  • petergrt on April 16 2017 said:
    On top of this, yesteryears' CAPEX $$ go twice as far and more today . . . .
  • Chad Ryan on April 17 2017 said:
    @ Edmund Paulus - I was equally perplexed by Arthur's assertions. That the break-even costs nearly halved year-on-year between 2014 and 2015 is simply not true. NPV is calculated using expected forward market prices, i.e. the break-even cost of the expected marginal barrel needed to balance the market. To be explicit: if LTO producers find efficiency improvements to lower their break-even from $65 to $50, the break-even cost for Saudi Aramco will remain the same, about $10, though their NPV will decrease.

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