By Mark Finley
Fellow in Energy and Global Oil
It’s been a rough year for US shale producers. Prices collapsed, investment collapsed, the rig count collapsed, jobs collapsed. And production collapsed: Indeed, in recent months we’ve seen the fastest oil production drop in US history.
But things are looking up. Prices have recovered, with the US benchmark of WTI now near $43 … the highest since the Saudi-Russia price war that followed the onset of the COVID-19 pandemic. The rig count has stabilized; the frac count is increasing. Moreover, the economy is recovering, stimulus programs have been adopted and interest rates are at record lows.
In the last big price collapse in 2015, Saudi Arabia, Russia and other competitors were surprised by the ability of US producers to stay competitive.
Are we looking at the same now?
Clearly the US shale industry has some strong factors working in its favor … but even so, I think the answer for now is: probably not.
When prices collapsed in 2015, even as investment and drilling activity collapsed, production recovered pretty quickly. It was back to pre-price-collapse levels by late 2017 even though prices had barely reached $50 (after peaking above $100 in 2014), and even though the rig count remained less than half the pre-collapse level. Investors were still willing to invest. Massive cost cutting helped the industry stay competitive … as did massive productivity gains. Between the price collapse and the end of 2017, excellent US Department of Energy (DOE) data shows that per-rig productivity nearly doubled in the Eagle Ford, more than doubled in the Bakken, and nearly tripled in the Permian.
The result last time: To the surprise and consternation of Saudi Arabia, Russia and other competitors, shale production came roaring back, with US crude oil production rising by a record 1.6 Mb/d in 2018. As you all know, this huge increase made the US the world’s largest oil producer, and led to the US becoming self-sufficient in oil for the first time in 70 years. That rapid growth also contributed to renewed weakness for oil prices even before the pandemic and Saudi-Russia price war.
How are these dynamics likely to play out this time around? It looks like a tougher task for the US shale industry to maintain its competitiveness in 2020.
First, while cost cutting is happening once again, it is unlikely that costs will fall as rapidly as they did in 2015-16. Quite simply, there was more fat in the system when oil prices were above $100, as they were for much of 2014. This time around, after the record US production increase in 2018, oil prices fell in 2019 (even with aggressive production cuts from OPEC and cooperating countries like Russia)—meaning the industry has already been in cost-cutting mode for several years. Service companies were being squeezed even before the pandemic and price collapse.
Moreover, we find ourselves in a very different investment climate today. Put simply, the oil and gas sector is out of favor with many investors, making it harder for the industry to access capital to fund new drilling. Many analysts believe the pandemic has accelerated the transition of the world’s energy system away from oil and other fossil fuels, and toward renewables. Futures prices show the expectation that today’s large global inventory overhang and high OPEC spare capacity may weigh on oil prices for some time. The energy sector as a share of the US stock market is at a record low; ExxonMobil has been removed from the Dow Industrials for the first time in nearly a century.
Perhaps most importantly, productivity gains have slowed as the technologies of horizontal drilling and hydraulic fracturing have matured. In the 12 months before the pandemic, DOE data shows that per well productivity in the main shale plays grew by around 10% — a significant improvement, but tiny in comparison to the rates of improvement seen in the last price collapse. (The most recent data from the DOE is difficult to interpret because their method includes the recent shut-in and subsequent restoration of supply from existing wells in their drilling productivity report.) Certainly, we can expect the industry to become more productive: As investment and activity have fallen, the best prospects will be drilled, by the best crews and the best rigs. But again, I think it’s highly unlikely that we will see per rig productivity double over the next few years.
And then there are decline rates. (Every shale well sees its production drop over time; here I will be referring to aggregate declines in the total US shale production base.) While DOE data shows that the average decline rate of US shale production pre-pandemic was similar to the rate seen at the onset of the last price collapse, the level of the monthly decline is much larger now (over 500,000 b/d per month, compared with about 350,000 b/d per month in late 2014) because the base of production is much larger now. That means the industry needs to bring about 500,000 b/d of new production online every month just to hold overall US production steady. Again, using DOE data, we can see that the amount of drilling happening early this year – pre-pandemic – was just barely sufficient to accomplish this. And since then the US oil rig count has fallen by 75%. Even with modest productivity gains, that means we would need to see a huge increase in new drilling/completions if we’re to avoid continued declines in US production.
Indeed, my calculations show that, assuming pre-crisis productivity rates and with no reduction in the inventory of drilled-but-uncompleted wells (DUCs) – which is what the DOE is reporting currently – we would need the rig count to more than double to keep production flat. That almost certainly overstates the amount of drilling needed: As mentioned above, productivity IS likely to improve, even if modestly; and despite the DOE analysis, many industry observers believe the DUC inventory is being reduced. Moreover, the dynamic of decline rates has been temporarily masked by the dramatic number of wells that shut-in as oil prices dropped below zero, and then were returned to production as prices recovered. But even with those considerations, I believe the US industry is operating at levels that make further production declines likely…and that it will take a significant increase in prices to incentivize sufficient additional activity to stabilize production. The DOE’s latest short-term forecast does predict a small drop in US production in December, but then believes US supply will stabilize before growing again by mid-2021. This is with a forecast that WTI prices remain near current levels through year-end and rise modestly to $48 by the end of next year. (Unfortunately, DOE does not publish a forecast for industry activity — rig count, wells drilled, etc.) To me, this feels optimistic.
In 2015-16, Saudi Arabia and Russia learned the hard way not to count shale out prematurely. And even today, it would be foolhardy to declare shale’s demise: I’ve written elsewhere that the hyper-competitive US shale industry is a massive advantage on the global stage. US production could certainly rebound if prices soar and industry investment once again takes off. It was widely reported that, in recent discussions among the OPEC+ producer group, Russia was reluctant to extend large production cuts because it is concerned that US shale producers will return to compete for global market share if prices firm.
But it’s equally true that this isn’t the shale industry of 2015. We — like Saudi Arabia and Russia — need to avoid basing our 2020 oil market analysis on 2015’s experience. To turn the old saying around: History may rhyme, but it doesn’t repeat itself.
This post originally appeared in the Forbes blog on August 31, 2020.