Oil and Gas

The Shakeout of US Shale Oil Break-evens

My favorite quote by H.L. Mencken is ‘a cynic is a man who, when he smells flowers, looks around for a coffin‘. A bit morose, I know, but this appeals to the contrarian in me. My second favorite is überly-applicable to US shale oil break-evens: ‘For every complex problem there is an answer that is clear, simple, and wrong‘. For there is no lack of estimates flying around as to the price level at which US shale oil production could be curtailed. The problem is, they all appear to be different.

The debate was ignited by OPEC, after comments from Secretary General El-Badri. The Libyan said late last month that tight oil (aka US shale) would be the first to be impacted by the drop in oil prices, stating:“If prices stay at $85, we will see a lot of investment, a lot of projects, a lot of oil going out of the market.” He said half of shale oil would be out of the market at a price of $85.

This view is at the high end of the range when it comes to estimates, with the IEA seemingly taking the other side of this bet. Executive Director, Maria van der Hoeven, said last month that 98% of U.S. shale plays have a break-even price of below $80.

The IEA’s Chief Economist, Fatih Birol, tempered this optimistic view in recent days, stating current low oil prices would hurt investment in the industry and likely hurt production growth going forward. That said, slowing production growth is very different from an Opecian view of ‘a lot of oil going out of the market’.

The below graphic of oil break-evens from the Wall Street Journal highlights the current conundrum faced. Not only are shale break-evens wide-ranging from play to play, but they can also wildly vary within each formation itself:

Further conjecture is stoked as oil prices have been unable to rebound back above $80. Oil producers on earnings calls are shrugging off the suggestion that this lower price environment is having any impact (either that or they are not being completely transparent).

The CEO of Halliburton, David Lesar – the world’s biggest provider of fracking services – endorses this notion somewhat, saying U.S. shale oil producers will be fine, as long as oil remains between $80 and $100. Meanwhile, signs of rigs being idled, from Texas to Utah is providing a counter-point to this argument.

The below chart from Goldman Sachs (via Zero Hedge) points to a price of $75 where production would start to slow, a number affirmed by other bank research:

In addition, the level of financial pain which each individual producer can withstand is going to vary wildly; larger producers may be more financially stable, while smaller producers may be more highly leveraged.

It was this Reuters summary of various bank estimates which instigated me to go all Mencken in the first place, as break-evens are so wide-ranging, given likely different methodologies and assumptions. The below graphic (pilfered from Business Insider) shows a similar trending to the above image, emphasizing the gravitation around the $80 mark:

So where does this leave us? Despite wide-ranging estimates, consensus indicates that some degree of US shale oil production would be impacted at around current levels. Whether this translates to a mere slowing in the rate of oil production growth due to lower future investments, or a more material crimping of production, is yet to be seen. But if OPEC seems intent on leaving this up to market forces as opposed to intervening to balance it, then it would appear we may well find out.

I leave where we started, and with a quote from H.L. Mencken: time stays, we go.


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