Harsh realities finally push US champions of shale oil into retreat

US crude oil output hit a 44-year peak of 9.6m barrels a day in April then began to decline.

By summer next year it will hava fallen by a tenth, the US Energy Information Administration (EIA) forecats.

It took months for US supplies to finally reverse in response to the tumble in oil prices that started in mid-2014. If prices creep higher again, any rebound in shale production will come with a similar lag, analysts say.

The US shale energy industry has made a stunning contribution to the oil market glut. Of the nearly 5m b/d in net global crude oil supply added between 2009 and 2014, 3.3m b/d was from the US, EIA data show. World supply stood last year at 93m b/d. Most new US supply flowed from states such as North Dakota and Texas, where drillers used improved drilling techniques to extract oil from previously difficult shale rocks.

After the rapid fall in the price of crude from mid-2014, analysts were at first surprised that US shale operators did not immediately capitulate by cutting production. Output continued to climb towards its peak in April this year even though drillers began to stop some rigs the previous October, according to Baker Hughes, the oilfield services company. There were several reasons for this state of affairs. Some investors betting on an oil price rebound were content to extend capital to beleaguered drillers on advantageous terms. Some shale producers had also managed to hedge their revenues to protect against declines in revenues caused by a fall in the price of crude.

Frackers also extracted more oil out of each well they drilled, with innovations including the funnelling of more sand into drilling holes to prop open rocks. In North Dakota’s Bakken shale region, new oil production per rig has risen by 43 per cent in the past year, according to EIA.

James Volker, chief executive of Whiting Petroleum, a leading Bakken producer, told a conference in early October: “So while we’re slamming on the brakes here and while we’ve reduced our drilling rig count from 24 in the middle of last year to eight today, we were nevertheless able to set production records.”

Finally, shale companies’ costs have declined between 20-30 per cent as they negotiate better terms with contractors keen to keep their equipment in use.

This has kept some operators afloat despite lower oil prices. However, the longer the slump persists, the tougher life has become for operators. While wells in the best areas can break even with oil at $30 a barrel, some marginal ones require prices of $70 or higher. As a result, producers are turning away from marginal areas and leaving some drilled wells uncompleted for now. Producers under financial pressure have in some cases decided to reduce capital spending. As a result, shale production is now falling.

The next victims of lower prices in North America will be projects with longer investment timescales than shale, such as those in the Gulf of Mexico and the oil sands of Canada. Billions of dollars of cutbacks in these areas will be felt later in the decade, analysts say.

Should there be a sudden rise in the price of crude, the shale industry could once again be spurred into increasing supplies. The question for oil analysts is how quickly this might happen.

In the short term the backlog of drilled but uncompleted wells — known as Ducs — could be brought into service fairly quickly. However, it takes months to drill new wells. Given this time lag and the unpredictability of supply disruptions across the world, a smooth return of shale output is not guaranteed.

Much will depend on the path of supply elsewhere, including Iran as it returns to the market after reaching a deal on its nuclear programme with western powers. Also uncertain is whether the Opec cartel will sustain its current policy of supplying unlimited volumes to put pressure on higher-cost producers such as US shale.

In spite of offering a path to energy self-sufficiency, the fate of the shale sector lies in the hands of foreign rivals.

G.M.