Frackers Can Still Rule The World’s Oil Markets

This is an Op-Ed that was published In MEES this week, written By Bernhard Hartmann and Saji Sam. The views expressed are strictly those of the authors, and do not represent those of MEES

When ‘Abd Allah al-Badri, Secretary General of the Organization of Petroleum Exporting Countries (OPEC), recently said the cartel’s decision to continue to pump oil in spite of collapsing prices is inflicting pain on US shale producers, he was right. One after another, US-based independent oil producers such as Carrizo Oil and Gas, Rosetta Resources, and Whiting Petroleum are reporting missed earnings estimates and plans to cut production.

But it’s way too early to count US-based shale producers out as major players in the oil markets in the future. Rather, what’s happening marks a historic shift in the companies acting as swing producers for the market by reacting swiftly to falling prices.

Shale producers have continuously improved their drilling and fracturing technology, increasing their efficiency and allowing them to break even at oil prices as low as $40/B, depending on the field. Shale producers are already competitive with many conventional fields. As a result, US oil output has been surprisingly strong in February and rapidly filling available storage tanks, according to the International Energy Agency’s latest monthly oil report released on 13 March.

These producers will only become more economical. Over the last three years alone, many American shale producers have cut their unconventional oil drilling and completion costs by 15-25% on average, our research shows.

In fact, many North American shale producers are already working toward reducing their breakeven point by as much as half. A lower break-even point could put shale on par with oil fields of many national oil companies.

By contrast, the cost of oil drilling in the Middle East is starting to climb. To maintain or improve production from maturing fields, Middle Eastern national oil companies will need to adopt enhanced recovery methods using more expensive technologies. They will also have to consider tapping into new reservoirs and fields, many of which are lower quality. It will likely cost more to produce a barrel of oil from these sourer, heavier, and tighter supplies.

So in effect, as OPEC acts less like a traditional “swing producer,” North American shale producers are stepping into the role. Since the Yom Kippur War in 1973, Saudi Arabia and other OPEC members have acted as swing producers by increasing or reducing their oil output to help the global market adjust to shortages or surpluses in supply and volatile prices. North American shale producers are now responding to market supply and price changes.

enter image description here

Rather than folding due to the decline in oil prices, many unconventional producers are just shrinking a bit until prices rebound back to a more desirable level. By allowing their producing shale fields to deplete naturally and curtailing drilling of new development wells, they are slashing their production in response to oversupply and low prices. But once supply tightens and the price of oil recovers, North American shale producers can quickly ramp up production in a matter of months, not years, by deploying hundreds of rigs in factory-mode drilling. Within the next decade, more unconventional oil and gas producers will likely join these existing players’ ranks. Shortages in rapidly growing regions such as Asia and Africa are likely to be further exacerbated by a rising number of countries taking unilateral action to cope with local scarcities. And the US has shown one relatively inexpensive and fast way for countries to seek energy independence is by exploiting their own unconventional oil and gas resources.

Until now, the US has dominated the unconventional oil and gas market in large part because its players have better access to cheap capital, stronger mineral rights laws, availability of water for fracking and an entrepreneurial and market driven supply-chain eco-system. But it’s only a matter of time before countries such as China, Russia, and Argentina figure out how to improve their environments for unconventional oil and gas drilling – potentially resulting in more regionalized oil markets in the long term. The estimated 156 billion barrels of oil equivalent unconventional resources in the US are only a small fraction of the 1.6 trillion barrels of unconventional oil and gas that exist worldwide.

So what steps should governments, national oil companies, and oil majors take to stay ahead of these shifts? So far, most are tightening their belts to survive currently low oil prices by cutting less valuable capital expenditures, renegotiating supplier contracts, and reconsidering stock buybacks and dividend payouts, which have exceeded the oil majors’ cash flows in recent years. Some are also opportunistically revamping their portfolios of businesses, workforces, supply chains, and risk management practices.

While these are practical short-term steps, the answer to beating low oil prices is not to count on a cartel to once again guide market forces, but instead to respond better to supply and demand dynamics. To come out on top, governments and companies should take advantage of market distress, while they can by rebalancing their resources to better meet shifting domestic and overseas demand and supply dynamics before the economic cycle reverses.

Governments in the Middle East, especially, should focus on improving their ability to deploy capital in initiatives that will maximize their localization by creating more jobs, while expanding their range of substitutes for energy imports and potential exports. They should pick up the acreage, technology, talent, and capabilities they need to compete in an oil market made up of many more nimble shale producers. Frackers are showing that a new, more market-driven, invisible hand is not influencing oil prices, but rather, being driven by them.

*Bernhard Hartmann and Saji Sam are Dubai-based partners in the Energy Practice of Oliver Wyman, a global management consulting firm.