US shale oil now almost not worth drilling

Houston — America’s shale producers already had a profitability problem. It just got a lot worse.

At a stroke, Saudi Arabia and Russia and their battle for market share have made almost all US shale drilling unprofitable. Only five companies in two areas of the country have break-even costs lower than the current oil price, according to data compiled by Rystad Energy, an Oslo-based consultancy.

Wells drilled by ExxonMobil, Occidental Petroleum, Chevron  and CrownQuest Operating in the Permian Basin, which stretches across West Texas and southeastern New Mexico, can turn profits at $31 a barrel, Rystad’s data show. Occidental’s wells in the DJ Basin of Colorado are also in the money at that price, which is where oil settled on Monday.

But that’s not the case for the rest of the shale industry — more than 100 operators in a dozen fields. For them, drilling new wells will almost certainly mean going into the red.

Shale projects are heralded for their ability to be quickly ramped up and down. But because output from these wells declines much faster than from their old-school, conventional cousins, companies have to drill more of them just to keep output flat. That has meant sluggish investor returns, one of the main reasons oil and gas represents less than 4% of the S&P 500 index.

At this point, “companies should not be burning capital to be keeping the production base at an unsustainable level”, said Tom Loughrey, a former hedge fund manager who started his own shale-data firm, Friezo Loughrey Oil Well Partners. “This is swing production — and that means you’re going to have to swing down.”

Already, producers including Diamondback Energy and Parsley Energy have said they’re cutting their drilling budgets and dropping rigs. Others, such as Apache and Occidental, have indicated they’ll rein in activity.

“What they’re not saying is that they’re going to suspend activity,” Loughrey said. In his view, a typical well in the Midland sub-basin of the Permian requires $68 a barrel oil for investors to make an adequate return within 24 months.

BloombergNEF expects producers to move away from using break-even costs that leave out overhead and other necessary expenses as investors shift their focus to cash flow.

“At a minimum, they will need to add back interest costs to their calculus,” BloombergNEF said in a report. That means the profitability floor for most new wells will rise to $50 a barrel “in the not too distant future”, according to the report, up from $45 in the past.

The shale boom turned the US into the biggest oil producer in the world and, in recent months, a net exporter of petroleum. But if prices remain near $30 a barrel, producers will be forced to axe so much drilling activity that US oil production could fall by 2-million barrels per day (bpd) from the end of 2020 to the end of 2021, according to Rystad.

That would be about a 20% drop.

On Monday, West Texas Intermediate (WTI) crude fell 25% to settle at $31.13 a barrel, and some forecasters see it falling toward $20. Prices clawed back some of those losses on Tuesday, reaching as high as $33.19.

“Even the best operators will have to reduce activity,” said Artem Abramov, head of shale research at Rystad. “It’s not only about commerciality of the wells. It’s a lot about corporate cash flow balances. It’s almost impossible to be fully cash flow neutral this year with this price decline.”

Bloomberg