Forget OPEC: Shale 2.0 Will Bounce Back & Even Stronger

  • Date: 19/01/16
  • Mark P Mills, The Wall Street Journal

Vast swaths of shale will be profitable with oil at about $40 a barrel, and the nimble industry is ready.

How low can oil prices go? When pundits start competing to predict where the barrel will hit bottom, you know that a rebound is inevitable. It’s the inverse of what happens before a high-price bubble bursts. Only a few years ago forecasters were suggesting that oil might hit $300 a barrel.

The unpleasant reality is that petroleum prices are cyclical. Starting with the 1973-74 Arab oil embargo, they have been through six extremes. Because the peaks and the valleys both wreak financial havoc, producers and politicians imagine a Goldilocks ideal, with prices “just right”—not so high that legislators feel pressure to claw back “windfall profits,” and not so low that suppliers fall like dominoes, destroying jobs and tax revenue.

The latter is what we’re seeing now, with oil falling below $30 a barrel. Survey the damage so far: More than 100,000 jobs are gone, most of them last year. The number of shale rigs in service has collapsed by 60%. Banks are worried about their oil loans. Shale states are readjusting budgets for shortfalls. About $200 billion of oil and gas assets are up for sale world-wide.

American shale oil companies—whose booming production is a principal cause of the global glut—have been hit hard. Last year two dozen defaulted and 15 filed for bankruptcy. Standard & Poor’s puts junk ratings on three-fourths of the oil and gas producers it monitors.

Here’s the big question, the one that makes this cycle different: What happens to shale oil? The jobs and revenues from America’s newest industry literally kept the country out of recession during the years of tepid growth that have characterized the current administration.

The bad news is that there will be more pain to come. Low prices will continue to drive out companies that are overleveraged or poor performers. Stronger firms might suffer collateral damage. In the end, though, most companies will survive. Many will emerge well positioned for the next cycle, having acquired new assets (at distressed costs) that can be deployed as demand rises.

Even with China’s economy slowing, global oil use will still rise by 1.3 million barrels a day this year—equal to the peak daily output of the entire Bakken Shale field. Middle-class automobile ownership in Asia is rising steadily, from today’s average of 60 to 80 cars per 1,000 residents toward the West’s 600 to 800 cars. All the fundamentals point to growing demand for oil.

When prices rise again, even modestly, as they eventually will, shale producers will be ready—and this is what worries OPEC, Russia and Iran. Many foreign producers need oil above $80 a barrel to balance their national budgets. Yet industry experts at RBN Energy foresee vast swaths of American shale profitable at just north of $40 a barrel. And it can come online extremely quickly. […]

When prices tick up, thousands of profit-seeking investors make individual decisions to turn each factory’s switch to “on.” That’s how the U.S. so rapidly achieved, from 2009 to 2015, the record-breaking rise in production of four million barrels a day. Remember, global prices are affected by changes of only one to two million barrels a day. The upshot is that absent something like a major war, oil prices won’t be able to spike again. That’s especially true now that America can finally sell oil in world markets, courtesy of Congress’s recent lifting of the export ban.

Shale 2.0, when it comes, will be even better. The technology is advancing at a speed usually associated with Silicon Valley. Over the past half-decade, average output per rig has risen at least 400%. Productivity rose 40% last year, despite cost constraints. The rigs are getting cheaper, and the efficiencies brought by the latest tools—from data analytics to robotics to advanced materials—have yet to be deployed.

Just as a new Internet ecosystem rose from the ashes of the dot-com crash, Shale 2.0 will emerge—and for the same structural reasons.

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