Flipping the coin: The two faces of shale oil

According to the US Energy Information Administration (EIA), the US is set to produce 9.36 million barrels per day through 2015.

Between the middle of 2014 and early 2015, the average price of Brent crude fell from $115.7 per barrel to $45.19 per barrel, a dramatic slide of about 60 per cent, according to the Oxford Institute for Energy Studies. Closer to the end of August 2015, the price had further alarmingly dipped to the environs of the $40s.
According to the US Energy Information Administration (EIA), the US is set to produce 9.36 million barrels per day through 2015, an increase of about 7.5 per cent over 2014. However, the prediction for 2016 by the US EIA indicates annual crude oil production of 8.96 million barrels per day. Is the forecast decline in 2016 a hint that American shale producers could come under pressure?
With the pressure on the oil price continuing unabated, there is some empirical evidence that it is having an impact on shale producers. Figures coming out from America reveal that the number of rigs in America has been falling steadily since oil prices started to fall. From 1,609 rigs in October 2014, the number of shale rigs fell to about 674 by August 25, 2015.
Independent oil companies in the US are already under a combined debt bill of $235 billion, according to Bloomberg. The downward volatility in oil prices has made investing in shale a highly risky proposition for banks and investors. In October 2015, American banks will reevaluate drillers' lines of credit. These evaluations are largely based on the value of reserves. Downward pressure on international oil prices means that many shale drillers, especially smaller ones, could be cut off from critical funding.
Resilience
However, there are arguments that shale production will continue to prove resilient, especially on the back of productivity gains. Some analysts point out that the marginal cost of oil from the American shale plays in North Dakota and Texas have fallen from $70 per barrel to about $50 to $60. There are more optimistic estimates that indicate breakeven prices of about $40, or even $30, in some shale areas.
The media in the US have reasoned, in some quarters, that drilling can be still be cost-effective for American shale enterprises at oil prices of even about $10, a key reason in terms of why many drillers have not yet shut production. In an environment of low oil prices, shale drillers have been compelled to adopt new technologies and continuously optimise cost structures.
The resilience of shale will be closely tied into impending supply and demand dynamics. Though the US shale oil production amounted to only five million barrels per day by the close of 2014, i.e., around six per cent of world production and consumption; its emergence in the middle of the industry cost curve meant that it has accounted for over 50 per cent of the increase in global supplies since 2010.
In its June 2015 meeting, the Organisation of the Petroleum Exporting Countries (Opec) decided to hold its member countries' collective target of 30 million barrels a day unchanged over the following six months in order to defend market share in the face of rising unconventional oil output.
The Opec's strategy of not seeking production cuts to underwrite the global oil price will hit American shale producers hard. For instance, in early August 2015, the CEO of Pioneer Natural Resources, a leading independent energy producing company in the US, said: "If oil prices go to $40 and stay at $40 for the next 18 months, we'll most likely slow down. But as long as our hedge positions and the [futures] strip occurs, there's no reason at this point in time to slow down."
Demand-supply dynamics
The international supply and demand scenario is undergoing a period of pronounced turbulence. The case of the key Chinese economy, following unexpected devaluation of the yuan and the tremors in the Chinese capital markets in August 2015, is a cause of concern for many oil-producing nations.
Elsewhere, in Europe, too, the recovery is extremely lax and automobiles are getting more and more fuel efficient. Thus, the portents for a reduction in demand for crude oil are getting enhanced.
Conversely, the recent nuclear deal between Iran and the major world powers may lead to a quick lifting of sanctions, allowing Tehran to pump more crude. Iran is determined to take back its lost market share of over one million barrels per day that it lost due to biting sanctions imposed in 2012.
Thus, a sustained low oil price environment in the neighbourhood of $40 or below may cause serious disruptions among many American shale producers, who may find it unfeasible to deploy additional capital. However, Opec may find itself faced with a persistent headwind as well. This is due to the fact that the shale technology and infrastructure would be on continuous standby, given the large sunk costs, to take advantage of any increase in global oil prices. Each episode of increase in global oil prices could be met with almost instantaneous production ramp up on the part of shale producers.
Elusive consensus
Moreover, Opec will likely find it difficult to sustain a consensus over long time periods, given the fact that Opec countries like Iran and Venezuela have budgetary oil price break-even prices that are markedly north of the $100 mark.
In the global oil marketplace, a plethora of players have developed that has injected much unpredictability into the system. The current search is for a new equilibrium in terms of oil price that can satisfy multiple players. Despite multiple forecasts as to what that price is; it is only the market and the unpredictable interactions between multiple players within it that can finally provide the answer. The fate of shale will depend upon finding a niche in that evolving balance.
The writer is the managing director of Marmore, a research house focusing on economies in the Middle East and North Africa. Views expressed by him are his own and do not reflect the newspaper's policy.