For the US shale industry, competing against Saudi Arabia and the other low-cost oil producers in the Middle East is like stepping into the boxing ring with the heavyweight champion.
At its latest meeting in November, Opec, the oil producers’ cartel, decided against a cut in output to support the crude price, sending it into freefall. Saudi Arabia, the cartel’s most powerful member, has insisted that this was not intended to be a “war on shale”, but Ali al-Naimi, the country’s oil minister, used a speech in Berlin this month to stress that it was not the role of Middle East nations to “subsidise higher-cost producers”.
North American shale companies are among those higher-cost producers, and evidence of the impact on them of the near 60 per cent fall in US crude since last summer is now mounting: in declining profits, cuts in jobs and investment and idled equipment. A handful of shale producers have gone bankrupt, while some others are struggling with large debts.
The number of rigs drilling for oil in the US has dropped 46 per cent from its peak last October, and this is starting to affect output. The US government’s Energy Information Administration said last week that in two of the three principal shale regions — the Bakken of North Dakota and the Eagle Ford of south Texas — oil production was expected to fall marginally next month. Only in the Permian basin of west Texas is it still rising.
But, so far, overall US output seems to be only levelling off, rather than collapsing. If US crude stays at its present level of about $45 per barrel, then it seems likely that production will start falling later this year. But Wood Mackenzie, a consultancy, is forecasting that US oil production will grow this year and next, if there is a rebound in prices to about $60 per barrel.
The industry’s ability to keep growing at lower prices than in recent years will depend on how far it can reduce its costs. Adam Sieminski, head of the EIA, says: “We have seen that shale oil works very well at $100 per barrel. Now we are going to find out if it works at $50 to $75.”
The round of earnings and outlook statements in recent weeks from the US exploration and production companies — the small to midsized independents that led the shale revolution — showed that while they are all cutting activity sharply, none is expecting a corresponding fall in output.
Even more than conventional oilfields, shale puts operators on a treadmill because the flow from each well falls rapidly after it is brought into production. Companies need to keep drilling just to hold output steady. Yet the US independents are telling their investors that they can maintain production roughly level, even while running many fewer rigs.
EOG Resources, for example, plans a 40 per cent capital spending cut this year but expects just a 3 per cent drop in production. Hess is cutting spending by 14 per cent but expects production growth of about 12 per cent.
Achieving the outcomes projected by US shale producers for this year would represent one of the most remarkable productivity performances ever achieved by any industry.
There is a precedent for such a dramatic improvement. After 2008, US natural gas prices collapsed, and some analysts predicted that shale gas producers would be wiped out.
The number of rigs drilling for gas fell from 1,606 in the summer of 2008 to just 268 last week. Yet US gas production has continued to rise.
Moreover, it is often the same companies that coped with the fall in gas prices that are now facing the same phenomenon in the oil market. They have to show they can perform the same feat twice.
The cost cuts and productivity gains that shale oil producers expect come in three categories.
First, there are savings from putting pressure on suppliers of drilling rigs, hydraulic fracturing and other services. Companies have generally been saying they expect reductions of 20 to 30 per cent this year.
Second, companies benefit from focusing spending on their most productive assets. “You’re dropping all your worst-performing rigs and worst-performing rig crews and moving the rigs you have to your core areas,” says Randall Collum of Genscape, an energy research firm.
Finally, there are productivity gains available from improved techniques.
Companies are able to drill more wells with fewer rigs using methods such as “pad drilling”. This minimises the downtime between wells as rigs are dismantled, moved and reassembled by drilling several from a single location.
EIA data show remarkable improvements in productivity, with production per rig from new wells rising in the past year by 24 per cent in the Eagle Ford, 29 per cent in the Bakken and 30 per cent in the Permian basin.
Last October, the median break-even oil price needed for shale projects was estimated by IHS, a research group, at $57 per barrel. Falling costs mean this year that number will be significantly lower. If crude prices do start to pick up again, many analysts and executives think US shale producers may be able to step up activity again and resume production growth even with oil below $75.
Although US shale is a higher-cost source of oil than some of the great fields of the Middle East, it may well turn out to be more resilient than Saudi Arabia and other Opec members would like.
‘Assembly line’ drilling planned to cut down costs
One way that US shale oil producers are attempting to drive down costs is by developing a so-called “manufacturing model” for drilling.
This involves standardising designs, equipment and techniques so that wells are less bespoke creations, and more like products coming off a factory assembly line.
There were 37,500 wells drilled in the US last year, but many of the benefits of that large scale have not yet been captured.
“Oil companies tend to change their minds a lot during the drilling process,” says Dennis Cassidy of AlixPartners, a consultancy.
“So you have a supply chain that is very inefficient, because it has a lot of inventory and a lot of inefficiency so it can respond at the last minute.”
Many companies are trying to learn from best practice in manufacturing to become more efficient. Some have even hired executives from leading manufacturers to show them how to do it.
Drilling a well out in an oilfield is a different proposition from managing workflow in a factory, but Mr Cassidy argues there are still large savings available.
“We’ve gone from the horse and buggy to maybe the Model T. We’re certainly not at the Tesla standard of state of the art modern manufacturing,” he says.
“We may never get to an A+ standard, but there’s such a long way to go still that even a B+ is light years better than what we currently have.”