It’s been quite a stretch for the oil markets in recent months. After a protracted decline that left markets sagging and producers scrambling for solutions, crude prices have rallied sharply and reached heights not seen in several years. The rapid growth has been driven largely by cuts from OPEC, Russia and other prominent producers, aimed at draining the massive global surplus that had seen prices tumble to below $30 a barrel as recently as January of 2016.
However, even as analysts and traders regain confidence, not everyone believes the sudden boom is as positive or sustainable as it appears. There are lingering concerns that shale producers in the United States and Canada may rush to increase production to take advantage of a more robust market, potentially triggering another round of oversupply-related price falls. Oilfields in Texas, North Dakota and elsewhere have already boosted production, but is the next great crash really on the horizon?
Shale Oil Economics
Shale oil, more so than oil produced by conventional means, is highly dependent on global market prices. Though there is a great deal of variability in the break-even price from well to well, fluctuating from as low as $30 per barrel to as high as $100 or more based on the cost of opening the well, the difficulty of accessing the oil and the eventual production capacity, many portions of the oilfield remain unprofitable when markets begin to sag. This often leaves many wells sitting idle until the market recovers, at which point the vast fields of Texas and North Dakota roar back to life. This sensitivity to market variations creates a boom-bust cycle that is even more pronounced than conventional oil, and if a bust is indeed looming, it would hardly be the first time.
The Booms That Went Bust
Beginning in the second half of 2014, oil prices plummeted precipitously in response to a global supply surplus. Crude prices were sliced in half in just four months, sending major shale oil producers into a period of strict austerity. Nearly 70 percent of the drilling rigs in the United States ceased production. The shale industry withered in the face of harsh spending cuts, shuttering more than 100 drilling and exploration companies and leaving the industry in a state of disarray – at least temporarily. The bust didn’t discourage shale producers entirely, however, and smaller boom-bust cycles followed again in the ensuing years.
Untapped Potential
Despite its unpredictability, shale oil remains a tempting prospect for producers and investors alike. This attraction comes in large part from the massive untapped potential of shale oil reserves. The recently-assessed Wolfcamp formation in Texas’ Permian Basin is the largest continuous deposit of oil ever assessed in the United States. Some analysts believe that the Permian Basin as a whole may hold as much as 75 billion barrels of shale oil, with many billions more scattered throughout North Dakota, Colorado, Utah and other oil-rich states. These massive shale deposits are a large part of the reason some recent industry analyses have concluded that the United States is sitting atop the largest volume of oil reserves of any country in the world.
Production or Profit?
Of course, all that oil still needs to be recovered, and that recovery requires significant capital investments. That’s been no problem through much of the shale oil industry’s existence, as major shale firms have burned through cash at a nearly unprecedented pace. Despite capital expenditures exceeding cashflows with startling regularity, many operators persisted with the kind of reckless drilling that often added unneeded supplies to the market without returning much in the way of profit.
Predictably, not everyone has been happy with this paradigm. Weary of these freewheeling, debt-riddled business practices, stakeholders have increasingly pushed for a more measured approach. Executives of many companies have talked up a leaner, smarter, more efficient plan of action that emphasizes profits rather than production. Discipline and restraint have become the hot new buzzwords, portraying images of an industry that has learned its lessons and committed to reigning in its worst excesses. Of course, all this talk began when markets were flagging and break-even prices were simply out of reach for many producers. Now that the arithmetic has changed, many have justifiably questioned whether such self-imposed austerity represents a genuine commitment or a matter of convenience.
Unpredictability in the oil markets is nothing new, but the unique nature of shale oil production injects an added measure of uncertainty. Shale producers have good cause to approach the resurging global markets with caution, and disgruntled investors represent a source of significant resistance to the sort of unrestrained spending that has often plagued the industry. Still, as prices continue to climb, major players will likely find it ever-harder to resist the siren song of those massive reserves sitting beneath their feet. The history is clear, but it remains to be seen whether anyone has learned the lessons it has to teach.
