Many U.S. shale drillers have said that they have full-proofed their operations for $40 oil, having lowered breakeven prices substantially over the last few years. They may soon have to prove it. Oil prices dropped to fresh seven-month lows on Tuesday, officially entering bear market territory, down more than 20 percent year-to-date. The declines have raised questions about the possibility of WTI hitting $40 soon.
A rising U.S. rig count, multi-year record production levels from Libya, and a general mood of pessimism more than outweighed the positive news that OPEC and non-OPEC producers increased their compliance rate in May. There is now a growing consensus that the OPEC deal won’t be sufficient to bring down inventories at a fast enough pace to balance the market this year.
Can U.S. shale survive in a world of $40 oil?
There are very different answers out there depending on who you ask. Most of the oil majors and some top shale companies such as EOG Resources, are said to have breakeven prices below $40 per barrel. That would suggest that their drilling campaigns would not stop even after taking into account the latest slide in prices.
But those are just the top companies, not everyone across the industry. Some smaller companies in more marginal parts of U.S. shale basins will face much more pressure in today’s market.
A long list of shale drillers have dramatically reduced their breakeven thresholds, lowering costs so that they could make money, by and large, with oil prices in the $50s. That is why the rig count surged over the past year.
But $40 oil is much different than $50-$55 oil. “We had $52 on average in Q1 and everyone said we are going to start growing again. Everyone said our balance sheets are fine,” Paul Sankey, a senior analyst at Wolfe Research, said on CNBC. “The market is now testing who can really stand up and run. At $52 the answer was too many people. Now at $43 we are going to really find out as we go into Q2 earnings who can really get this done at $43. And I can tell you, there’s not many companies that we like…Most of the sector has got an awful problem down here for sure.” UBS says that oil at $45 per barrel “slows most U.S. shale plays.” The Bakken, the Eagle Ford and the Niobrara struggle below $45. But if prices drop to $40, companies will be forced to “hit the brakes,” even in the highly-sought after Permian Basin.
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So even as shale executives talk up their cost reductions, they will be put to the test in the near future. “We are nearing the point where it’s going to be a challenge for them as well, if you break $40 per barrel,” John Kilduff of Again Capital told CNBC.
“With oil at $45, there will be very little movement in capital globally, and fewer projects will get sanctioned,” David Pursell, an analyst at the investment bank Tudor, Pickering, Holt & Co., told the Houston Chronicle.
Because there is a lag between oil price movements and rig counts, the effect of the recent slide in prices might take some time to become apparent. Moreover, with rigs already out in the field drilling, production might continue to rise even if prices fall.
But if prices fail to rebound, the gains in the rig count could start to slow. Companies would have to start thinking about paring back their drilling campaigns the longer that oil prices stay in the low or mid-$40s. “[T]he rate of growth in drilling we’ve seen over the past year might not be sustainable through the year and certainly not into 2018,” said Jesse Thompson, a business economist at the Houston branch of the Federal Reserve Bank of Dallas, according to the Houston Chronicle. “At a certain price point, you’ve eventually saturated the drilling you can afford to do.”
The equation, however, would really change if oil prices continue to fall even more. “I think we most definitely go to $40. We’re probably looking at the upper-$30s at this point now,” John Kilduff told CNBC.
By Nick Cunningham of Oilprice.com