The latest oil rally, which sees crude trading at close to its highest point in three years, is sufficient to garner considerable attention from market pundits, industry insiders and investors alike. It has raised the ugly specter of a sharp uptick in U.S. oil production driven by the much-anticipated shale oil boom.
Yet, there are signs that the potential for U.S. shale oil companies to rapidly expand production and return to the boom years witnessed before the prolonged oil slump appears overblown.
There are a range of constraints poised to prevent the rapid production growth many mainstream analysts had been predicting.
It was only in early December last year that an MIT study was released concluding that the U.S. vastly overstates oil production forecasts and that the EIA has been exaggerating the effect of fracking technology on well productivity.
According to MIT research, the EIA assumes that regular improvements in drilling technology and well design are boosting output at new wells by around 10 percent, yet their own research shows that it is closer to 6.5 percent. That, along with the EIA’s own monthly production data, which shows that U.S. oil output between January and November 2017 grew at a far more modest monthly average of 1.3 percent, indicates that the EIA’s weekly forecasts could very well be overstating U.S. oil production.
In the past, the optimistic figures provided by the EIA have suppressed the price of West Texas Intermediate or WTI, and this in part has been one of the contributing factors to the significant premium that has existed between WTI and Brent.
Nevertheless, that premium is closing, having fallen from over $6 per barrel at the start of 2018 to less than $4 for the last week of January 2018 amid falling U.S. inventories.
Some analysts think this could lead to a reduction in demand for U.S. oil exports, which would reduce the incentive for shale oil producers to ramp up production.
Claims that shale oil possesses exceptionally low breakeven costs, which, coupled with WTI trading at over $60 per barrel, will spark a massive surge in activity appear overstated. While it’s true that considerable improvements in technology and drilling techniques have caused costs to fall, they aren’t as low as many analysts believe.
In late 2017, Reuters reported that an analysis of second quarter 2017 financial results revealed that breakeven costs were $50 per barrel — well above the sub $40 prices claimed by Rystad Energy in mid-2016. Breakeven costs are different from company to company as well as shale formation to shale formation, making them unreliable indicators on which to solely base production growth analysis.
Despite claims that shale oil companies intend to significantly boost production with WTI trading at over $60 a barrel, there are growing signs of restraint.
Bottom line: Unconventional oil producers have yet to demonstrate that they can consistently make profits.
According to oil industry consultancy Wood Mackenzie, that won’t occur until WTI is routinely trading at $63 per barrel, which they believe is unlikely until 2020.
There’s also considerable pressure being applied to shale oil companies by institutional investors to exercise restraint and avoid the excesses of the shale oil boom. Excesses of the shale oil boom and the sharp decline of oil prices were also subjected to by shareholders and institutional investors. That has seen industry leaders promise far greater restraint and to take a disciplined approach to the deployment of capital as well as drilling in an attempt to reduce debt and generate returns for shareholders.
If they follow through on their promises, which according to Goldman Sachs is highly likely, it’s another factor that reduces the likelihood of any substantial uptick in U.S. oil production occurring.
Another factor that many analysts who believe that shale could come roaring back is that oilfield services are becoming quite constrained. When this is considered in conjunction with rising costs and growing labor shortages, not only will it slow down any rapid expansion of shale oil production, but it will trigger an increase in breakeven costs, making it less attractive to drill.
Executive chairman and CEO of Eagle Ford shale driller Freedom Oil and Gas, Chuck Yeager, believes that a lack of capacity in the oil field services industry will act as a constraint on drilling activity. He went on to state:
“The services industry is pretty well fully-utilized and is not rapidly gaining capacity.”
While some analysts believe that higher prices will lead a surge in output, there are several factors that could prevent shale production from rapidly expanding and threatening higher oil prices.