WASHINGTON – When oil prices suddenly collapsed, going from $ 100 per barrel to $ 50 or less, the almost universal prognostication was that the US shale oil industry wad dead. Shale oil is difficult to extract and therefore a lot more expensive than “conventional oil”. Given the very low margins, shale oil can be profitable only if crude prices stay above $ 70 or 80 a barrel.
Kill shale producers
As we know, oil prices collapsed because Saudi Arabia and OPEC decided not to cut production in order to stabilize prices after the world experienced a supply glut thanks to US shale oil coming on line on a massive scale.
Many observers believed at the time that Saudi Arabia allowed the price free fall because it hoped to kill most US high cost shale producers. With oil at $ 60 or lower per barrel a majority of US producers would simply have to shut down. With global crude prices that low, US shale oil producers could no longer generate any profits, because of their high cost and low margin operations.
Well, the predicted US shale oil industry collapse did not happen. And this is mostly because the impossible actually happened. Many US producers learned new ways to cut costs, in a major way –and very fast.
Dramatic cost cutting
This sounds impossible. Oil production is a complicated, cumbersome and expensive process. Shale oil production even more so. You spend a lot of money acquiring drilling rights, spend more money drilling a lot. If you are lucky, you find some oil. After that, you have to set up expensive, capital intensive operations.
All this is based on the expectation that after you start producing you will generate a reasonable profit. But this expectation rests on the assumption that crude prices will stay within a certain range. If prices collapse, you are in a bind. Below a certain point, you cannot recover your initial investment in the drilling operation, and you start losing money. Therefore, you shut down, or you go bankrupt, or both.
But these generally accepted parameters no longer apply. At least not to all shale oil producers. And here is why. Believe it or not, the fact that shale oil wells production cycles are shorter than production cycles from conventional wells has become an opportunity for many industry practitioners to adopt new cost saving technologies that made the next shale well cheaper and more productive.
It would appear that more drilling resulted in more experimentation and eventually in higher productivity and better margins. At least in some instances, producers indicate that they have higher margins now, with oil at $ 65 than what they had when oil was at $ 95.
Let’s be careful. This does not apply to all. There are thousands of shale oil producers in the US, some of them quite small. Some small companies carry a lot of debt. Their business model is based on high prices. Therefore they will not survive. But many others can and will.
Will shale oil survive?
The issue of shale oil long term staying power is far from settled. How far can producers go in their efforts to cut costs via the adoption of improved drilling technologies? How much more shale oil is out there? In other words, is American shale a real game changer, or is it just an interesting but temporary phenomenon?
We still do not know that. That said, Saudi Arabia’s low prices policy may have unpleasant repercussions for the oil kingdom. There is no question that the Saudis can still make a good profit with oil prices at $ 60 or even less, because their extraction costs are very low.
Will low oil prices hurt Saudi Arabia?
But Saudi Arabia desperately needs a huge oil revenue to keep the country going. Simply stated, beyond oil there is practically nothing else in Saudi Arabia. Oil revenue finances almost everything. A long season of diminished revenue may cause significant cash flow problems. And cash flow problems may turn into political issues in an autocratic country in which loyalty is bought in large measure with subsidies and other forms of public largesse.
In the end, a policy that supports low oil prices forced the US shale oil industry to adjust very rapidly. Can the Saudi state adjust just as rapidly? I wouldn’t bet on it.