WASHINGTON – The US shale oil and shale gas revolutions have radically transformed global energy markets. Thanks to shale, the US now produces 9 million barrels a day. However, right now the focus is on how this booming sector will be affected by the dramatic drop in global oil prices. (Shale gas is a very different story. There is no global price for natural gas. Unlike oil, natural gas markets are regional. The value of natural gas is in its lower cost compared to coal or other power generation technologies).
The shale oil revolution
There is no doubt that shale oil is great for America. The ability to develop shale oil has allowed the US to become once again a major energy producer. Consider this. North Dakota, in the span of just a few years, managed to move its oil production from practically zero to 1 million barrels a day, this way becoming the second largest oil producer in America. However, producing this oil is quite expensive, compared to –say– getting crude out of the ground in Saudi Arabia.
Low prices caused a squeeze
And this is the problem. You see, extracting shale oil is way too expensive. It made perfect sense to invest in this business when oil prices were well above $ 100 a barrel. But now they are below $ 80. And this dramatic drop creates huge problems, especially for US small and medium seized shale producers who need oil above $ 75 in order to make a profit. If oil prices stay so low or get even lower for much longer, many small companies will go out of business.
What are the margins?
However, several analysts believe that for most producers there are still decent to good margins even with oil below $ 80. Those who operate in the Permian basin in West Texas are still OK with oil prices between $ 57 and $ 75. According to other estimates, prices need to go down to $ 65 or $ 60 or even lower in order to bring most of the US shale oil sector to a halt.
Of course, none of these estimates can properly factor technological innovation that can bring down shale oil exploration and extraction costs. Let us not forget that shale oil production is the child of ingenuity. Until a few years ago nobody believed that extracting oil from shale would make any economic sense, whatever the price of crude. It simply could not be done.
More resilient than you think
Needless to say, major technological breakthroughs cannot be willed into place right now, simply because industry needs them badly. But I am sure that the squeeze on profits caused by the current low crude prices will incentivize investments in cost cutting innovation.
Sure enough, because of the squeeze on profits, many US energy companies will go out of business. But I would bet that the sector will prove to be far more resilient than what oil analysts in Saudi Arabia now believe.