Crude Economics
When Should U.S. Shale Producers Worry?

If you haven’t heard, the price of oil in world markets is plummeting. Brent crude, Europe’s benchmark, is hovering around $91 a barrel, less than two months after some predicted it would stay above $100 forever, while in the US, the West Texas Intermediate (WTI) benchmark is down below $87 a barrel. These prices are a function of both supply and demand, but they also affect each in turn. On the supply side of things, there’s a growing worry that if the price of oil continues to drop, shale formations—which are technically difficult and relatively expensive to exploit—will cease being profitable. Bloomberg reports:

“If prices go to $80 or lower, which I think is possible, then we are going to see a reduction in drilling activity,” Ralph Eads, vice chairman and global head of energy investment banking at Jefferies LLC, which advised 38 percent of U.S. energy mergers and acquisitions this year, said in an Oct. 1 interview. “It will be uncharted territory.” […]

Shale oil is expensive to extract by historical standards and only viable at high-enough prices, Ed Morse, Citigroup Inc.’s head of global commodities research in New York, said by phone Sept. 23. Oil from shale formations costs $50 to $100 a barrel to produce, compared with $10 to $25 a barrel for conventional supplies from the Middle East and North Africa, the Paris-based International Energy Agency estimates.

“There is probably something to the notion that if prices fell suddenly to $60 a barrel, the production growth would turn negative,” he said.

The requisite price of oil for producers to profitably drill varies across American shale formations, so there’s no single number to point to as an indicator that the shale boom is in jeopardy. But should WTI crude start trading in the $70 to $80 per barrel range, U.S. crude production would start to be affected.

This serves as a timely reminder that energy independence is a myth; oil is a globally traded commodity, and the goings-on abroad, both on the supply (with Libyan crude coming back online) and demand side (with slower growth in China affecting projected crude imports there), can still affect America’s energy concerns. Oil is a globally traded commodity, and even if we produced enough oil to no longer need imports, unless we decided to go full isolationist, we’d still be affecting by global pricing of the stuff.

We may be more energy secure these days, but U.S. shale producers will still watch global markets and the events that affect them closely.

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  • Andrew Allison

    Another way of looking at this is that U.S. shale effectively puts a lid on domestic oil and gas prices: as the price goes up, supply will increase rapidly.

  • vepxistqaosani

    Actually, they should worry if the Democrats maintain control of the Senate, with all the potential for EPA and Keystone XL mischief that will bring.

    It would be quite ironic if the one piece of good economic news for working folk — lower gas prices — so lessens economic worries among voters that the Democrats manage to win the key “battleground” races, given that the Democratic party is universally and enthusiastically against all forms of energy that do not require government subsidies (and, thus, government control).

  • Jacksonian_Libertarian

    So you’re saying that falling oil prices are a bad thing? That’s nuts! That the oil producers are going to be competing for my energy dollar is a very very good thing. It’s good for me and every consumer, as well as the oil producers that will be forced to improve their Quality, Service, and Price in order to stay in business. Since US shale producers are already massively improving their production methods and lowering their costs of production as a recent graph on this blog made clear, they will have a huge head start on conventional producers elsewhere at staying competitive.

  • neshobanakni

    What would the world price be if one producer suddenly lost all capacity? Say … Iran?

  • David B. Pecchia

    Energy independence is not a myth, it is just that it will only happen in pretty awful conditions: If crude prices get high enough, then consumption will fall and domestic production will climb. There is some price such that they will be equal.

    • Edward Callahan

      The same applies to just about any good or service. Adam Smith called it the law of supply and demand and it is generally a reliable guide to predicting prices. Unless the lefties succeed in repealing it through taxes, regulations, subsidies and other distorting economic tactics used in the name of “fairness”.

  • old guy

    I wonder how much of this may be due to established oil countries pushing down the price so fracking becomes “too expensive”
    Paranoid – a bit but based on 60+ years of observing, not too paranoid.

  • GlobalTrvlr

    Shale oil wells are more expensive in the exploratory and drilling stages, but once in place, what is the breakeven on the variable cost? We now have a ton of shale oil wells in production, would they be curtailed with the lower prices or just new wells?

  • Edward Callahan

    “Oil from shale formations costs $50 to $100 a barrel to produce,”. This fact basically means that the world price of oil will be capped at aprox $90-100. Above that, American shale oil becomes economically viable and hence available to fill in supply shortages (after a short time gap) if the Saudis try to manipulate supply again. A far better situation than we had forty years ago.

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