OPEC’s Problem: There Is No Minister of Shale
Today’s U.S. oil producers are more like tech startups than big, integrated crude producers
By Greg Ip in the Wall Street Journal
When Saudi Arabia launched a global oil-price war last year, most market players assumed America’s high-cost, financially fragile shale producers would be first to retreat.
Some retreat. American companies have been quick to idle rigs and lay off workers, but U.S. onshore oil production has gone up since last fall, not down.
As oil ministers from member countries of the Organization of Petroleum Exporting Countries meet this week, they are grappling with the fact that the world’s new swing producer is a very different animal from their traditional competitors.
Shale-oil companies have more in common with the technology startups of Silicon Valley than the big, often state-controlled, integrated oil companies that dominate global oil markets. They are smaller, more nimble, take more risks and are more tied to the ebb and flow of the capital markets.
This agility has enabled them to boost productivity, raise cash, and so far withstand Saudi Arabia’s campaign to claw back market share from higher-cost competitors. One consultant who speaks frequently with Saudi officials says they “were surprised at how fast oil prices fell and how resilient shale was.”
In an industry dominated by behemoths, the U.S. oil industry stands out for its fragmentation. It takes 77 companies to generate 75% of American output of crude oil and related liquids, the most among the world’s 20 largest producers, according to Rystad Energy, a consulting firm. Only Canada and the U.K. are similarly fragmented.
By contrast, the comparable figure in Russia is four, in China, three, and in Brazil, one. In Saudi Arabia, Iran, Mexico and Kuwait, one state-controlled company accounts for nearly 100% of total output. While some of these companies are nominally private, all must respond not just to market conditions but the dictates of national policy.
In OPEC’s heyday, member oil ministers would meet to determine production quotas in an effort to keep prices stable. At times they might even seek the cooperation of non-OPEC producers such as Russia and Norway.
If OPEC ministers wanted to do the same now, who would they call? There is no minister of shale.
The U.S. oil industry wasn’t always a paragon of free-market competition. John D. Rockefeller’s Standard Oil monopolized refining until trust busters broke it up in 1911. When surging east Texas output in the early 1930s caused the price of oil to crash, the Texas Railroad Commission stepped in to regulate supply. It did so until 1972 when it allowed the industry to produce flat-out to meet climbing demand. The role of price arbiter then went to OPEC.
Until shale came along, new oil increasingly came from complex and costly deposits in politically unstable places or deep water.
Then, independent producers using innovative techniques, such as hydraulic fracturing of dense shale rock and horizontal drilling, learned to extract oil profitably from existing deposits. The industry is young enough that producers are still learning to cut costs, so the break-even price at which they can profitably produce keeps dropping, says Lars Eirik Nicolaisen of Rystad. By contrast, “the conventional onshore and offshore industry has seen complexity and break-even prices rise.”
As with tech startups, investors didn’t expect shale companies to pay dividends or repurchase stock, but rather to plow their cash flow, and the proceeds of stock and bond offerings, into drilling and production.
Thus, when oil prices and share prices turned down, many companies were expected to founder. But that hasn’t happened. Harry Mateer of Barclays notes shale companies have been quicker than integrated companies to slash capital spending. And thanks to low interest rates, stock investors and private equity funds are still eager to pour money into shale.
Now, as companies cut back capital spending, they boast that they are squeezing more out of what they do spend, a process reminiscent of how Toyota revolutionized car manufacturing by continuously eking out new efficiencies. They are drilling multiple wells from a single pad, or more efficiently targeting well bores at the most productive layers of rock.
According to Goldman Sachs, the average rig in Texas’ Eagle Ford shale now yields 5,000 barrels a day in its first year, compared with less than 2,000 in 2011. The firm thinks most shale-oil reserves are profitable to extract at $60 a barrel (roughly the current world price), $20 less than last year.
Low prices will eventually catch up with shale. Onshore oil production in the lower 48 states (which is dominated by oil extracted from unconventional formations such as shale) hasn’t fallen yet, but the U.S. Energy Information Administration thinks it will, starting about now. Many producers have yet to feel the full effect of the drop thanks to hedging, but those hedges will eventually expire.
When the tidal wave of stock and bond money that financed the telecommunications- and tech-stock bubble 15 years ago dried up, many companies went bust or succumbed to takeovers. Something similar may soon happen to the more indebted, less profitable shale operators. The industry, for all its similarities to Silicon Valley, is much more capital-intensive.
But just as electronic commerce and broadband Internet survived the collapse of the tech-stock bubble, so will shale oil’s innovations survive the current slump in prices. OPEC’s world will never be the same.