Sunday, December 7, 2014

How Falling Oil Prices Will Strangle the Shale Oil Boom

Economist magazine explains:
The boss of Continental Resources, Harold Hamm (whose fortune has dropped by $11 billion since July), has said he can cope as long as the oil price is above $50. Stephen Chazen, who runs Occidental Petroleum, has said the industry is “not healthy” below $70. The uncertainty reflects the diversity of activity. Wells produce different mixes of oil and gas (which sells for less). Transport costs vary: it is cheap to pipe oil from the Eagle Ford play, in Texas, but expensive to shift it by train out of the Bakken formation, in North Dakota. Firms use different engineering techniques to pare costs.

Two generalisations can still be made. First, in the very near term, the industry’s economics are good at almost any price. Wells that are producing oil or gas are extraordinarily profitable, because most of the costs are sunk. Taking a sample of eight big independent firms, average operating costs in 2013 were $10-20 per barrel of oil (or equivalent unit of gas) produced—so no shale firm will curtail current production. But the output of shale wells declines rapidly, by 60-70% in their first year, so within a couple of years this oil will stop flowing.

Second, it is far less clear if, at $70 a barrel, the industry can profitably invest in new wells to maintain or boost production. Wood Mackenzie, a research consultancy, estimates that the “break-even price” of American projects is clustered around $65-70, suggesting many are vulnerable (these calculations exclude some sunk costs, such as building roads). If the oil price stays at $70, it estimates investment will be cut by 20% and production growth for America could slow to 10% a year. At $60, investment could drop by as much as half and production growth grind to a halt.


  1. Obviously the Saudis are huge beneficiaries of this, as they likely have the wealth to weather it. Once the US producers go broke, the Saudis will be in the drivers seat again. I suspect Obama and his leftist environmentalist supporters are also secretly - or maybe not so secretly - delighted. The Saudis should be thanking them for their support.

    1. Firstly, US producers will not "go broke." They'll just curtail production and investment given the price level.

      Secondly, strategically, I personally feel this is a myopic move by the House of Saud. Unless they understand the long-term ramifications of their actions, then it becomes nefarious. There is a huge dependency on oil exports for sovereign nations in the Middle-East. Lowering the price by increasing supply creates even more instability in that area because it lowers national incomes.

      Thirdly, unless the House of Saud is willing to perpetually keep production up to stuff the price, once the price level eventually rises to shale profitability levels, you have the same issue again.

      Lastly, if they are doing this at the behest of the US Government in order to punish Russia due to the US Foreign Policy stance on the Ukraine, this is even more evil. This is overtly stoking fires in order to justify more US intervention overseas.

  2. Seems like another fed created boom and bust cycle. This time it's oil.

  3. The Fed has nothing to do with it, it's global economics. The Saudis did the very same thing in the mid to late 80's to derail 'stripper production' that augmented a large percent of overall U.S. production; then the oil glut made it unprofitable to maintain those stripper wells and they were shut-in. That resulted in the throwing of hundreds of thousands of experienced oil professionals out of work for upwards of 5 years. Crippled the industry. After a slow rise back to good profitability, the shale revolution caught fire. We danced with high production but now the Saudis changed the tune and here we are again.