Pressurising the U.S. shale industry: crude oil’s price collapse

Written by Paul Lowrie and Robert King.

Blamed on OPEC’s indecision in the face of weakening global oil demand and increasing global oil supply, the price of crude oil has plummeted over the last six months. In June 2014, the price of Brent crude oil hovered above USD 110 per barrel yet by mid-January 2015 it had hit USD 48 per barrel, a 6 year low. Whilst prices have stabilised somewhat in the last few weeks, Morgan Stanley has cut its 2015 outlook for Brent crude oil to USD 70 per barrel and the CEO of Kuwait Petroleum Corp has warned that the price of oil will not rise above USD 64 per barrel until at least mid-2015.

For the shale industry, crude oil’s price collapse raises deep concern. Many initial investors were drawn to shale due to the desire of many countries, including the U.S., to become less reliant on an increasingly expensive crude oil industry as prices continued to rise. The dramatic fall in oil prices has largely undermined this economic incentive.

The uncertainty surrounding the fracking industry’s economic viability has already had a detrimental impact on shale investment in the U.S. According to the DrillingInfo website, new well permits in the U.S. decreased from 7,227 in October 2014 to 4,520 in November 2014 as a result of this uncertainty. In November 2014, the International Energy Agency predicted that falling crude oil prices would reduce investment in U.S. shale by 10 percent in 2015.

Furthermore, the Bank of America’s 2014 year-end report states that 15 percent of US shale producers are already experiencing financial difficulties as a consequence of current crude oil prices. The report emphasised that this figure could rise to 50% if crude oil prices remain below USD 55 per barrel.

Despite these increasing pressures shale gas production in the U.S. is still predicted to grow in 2015. The U.S. Energy Information Administration (the “EIA”) predicts that the major U.S. shale fields will increase production in early 2015. For example, it predicts that the Permian Basin and the Eagle Ford fields will produce 46,000 and 30,000 more barrels daily respectively in January. Moreover, it predicts that shale drilling and exploration activities at the Bakken, Eagle Ford, Niobrara and Permian Basin fields will remain strong throughout 2015.

The recent annual report of the International Energy Agency setting out its five-year outlook seconds this more positive outlook. It notes that while “the price correction will cause the North American supply ‘party’ to mark a pause; it will not bring it to an end”.

Such predictions have bolstered the general opinion that the U.S. shale industry will survive a sustained reduction in the price of crude oil, but it remains to be seen what the industry will look like in 5 years’ time. Lower crude oil prices should trigger the introduction of more cost effective extraction methods that maximise capital expenditure and return on investment, and future development is likely to be centred on the major shale plays which produce the vast majority of the output.