When oil prices went into free fall in the fourth quarter of 2014, the question on everyone’s mind was whether unconventional resource development in the US, or shale oil development, would slow down. After all, many of the US shale and tight oil plays had oil price breakeven costs estimated at $60-$65/bbl (some even higher). Today, however, the role of US unconventional development in the global energy mix is even stronger than it was prior to oil prices falling, despite virtually all players having reduced capital expenditures and lowering rig counts.
Far from stopping unconventional development, low oil prices are rather focusing the US unconventional industry on operational efficiencies, forcing it to drive down costs and increase productivity while supporting the spread of US shale and tight oil services expertise internationally. This sector also expects to see more M&A activity as the most efficient players get bigger and the smaller, less inefficient players are squeezed out.
The real significance of continued development of unconventional resources is the short-cycle and flexible nature of the resource compared with the longer-term and inflexible nature of conventional resources. For companies who also have conventional assets in their portfolio, having unconventionals is another lever to manage risk. Over the past few months, some producers have publicly stated that large parts of their portfolio are economic at $40-50/bbl. However, under weaker oil prices, the value question is “why monetize at ~$50/bbl when you have the option to defer development?” Unconventional wells can go from exploration to production in less than a year. There is even another layer of flexibility and optionality that we are seeing. Some companies are drilling unconventional oil wells but waiting to complete them, allowing them to use the rigs they have under multi-year contracts while also waiting for the completion costs to go down and/or the oil price to go up. This inventory of wells that are drilled but not completed can be brought on stream quickly.
Also, while the weaker oil price is leading to a downturn in the US oilfield service sector and pressure on costs and margins, the softening of demand in the US is improving the availability of unconventional resource services needed to support international unconventional development. Given the downturn in the US, services companies and other unconventional suppliers are now looking towards other markets (e.g., Argentina, Saudi Arabia, and China) for new opportunities.
In 2015, US unconventional production is likely to stay flat or even decline as players wait for the oil prices to increase, which is a prudent business decision in the short term. But if 2016 comes around and oil prices are still at ~$50/bbl, then producers may start releasing production and unconventional development will start to grow again. For those players who also have conventional plays in their portfolios, lower oil prices are also demonstrating the value of having short-cycle investments allowing them to reduce overall risk and create optionality.