Oil: Thoughts on Shale

One of my potential short-term impacts to oil prices is shale. Shale production is at least one reason why oil prices started to tank. And now, even with oil prices now rising, everyone is worried that US shale producers will chase the rising prices and drive prices back down.



What is the current concern regarding US shale:

There is an expectation that US oil production will hit 10 million barrels a day by 2018.

As can be seen via this U.S. Energy Information Administration (EIA) chart, US oil production was around 9.2 million in August 2017 (if you click on the link, you can see that the number does fluctuate). If US production were to rise to 10 million barrels per day, it'd make up around half of what OPEC/Russia is trying to reduce on a per day basis, 1.8 million (agreement is until March 2018 though there are discussions currently about extending the deal for all of 2018).

So if US oil production increases, the market balance that OPEC hopes to get to won't happen.

Jim Chanos on the current state of shale

Shale production isn't all that profitable. And yet production has increased. Why is that? Per a quote from the WSJ, the Al Walker the CEO of Anadarko Petroleum stated, "The biggest problem our industry faces today is you guys." By "you guys," he meant investors. Investors kept pouring money into shale.

If you click here, you will see a Bloomberg interview with Jim Chanos. He states that shale wells deplete quickly and corporations are always having to raise more funds. All this while they're not very profitable. Their wells deplete quickly, they aren't profitable enough to invest based on their own cash flow, so they constantly have to borrow more money. This just leads to debt constantly increasing.

If oil expansion continues based on the above storyline, shale could negatively impact prices.

Why shale won't impact prices: is financial discipline coming?


There is an argument for why US shale producers will become more careful from now on. Per another Bloomberg link:

“Investors are no longer rewarding ‘growth at any cost’,” said Martijn Rats and Amy Sergeant at Morgan Stanley in a note published late last week.

So initially, investors were pouring money into shale. As per Chanos, profits were thin and oil wells were quickly running dry, resulting in the constant need to raise more funds. Investors are realizing what is happening and are demanding a more disciplined approach.

Why shale won't impact prices: will lack of productivity impact shale?

I've read articles that touted how productivity gains were driving break-even prices down. It appears there is a limit to productivity gains.

Via the Houston Chronicle, productivity gains can often be variable based on labor and equipment demand:

As a surge of drilling got underway and companies dispatched more rigs and fracking equipment across the vast plains, labor and equipment costs also began to climb, eating into the industry's bottom line.

One could say that all the productivity gains I was reading about was when shale production hit a rough spot and so labor and equipment became plentiful and cheap. Now with shale production increasing again, labor and equipment is becoming scarce and prices are increasing.

So an all out push for oil may not make sense due to these constraints that aren't really productivity gains.

Why shale won't impact prices: too many shale wells

Does shale drilling itself put limits to shale output? Per Bloomberg:

As production from wells rapidly declines drillers are rushing to add new ones at a faster pace in order to keep increasing output. The problem is that drilling multiple wells closer together is contributing to the drop in established ones, and sometimes causing harm that can't be fixed.

The article doesn't go into details on why this is happening; however, nature itself may put a cap on how much shale oil can be drilled and therefore it's impact on oil prices