From The Wall Street Journal
March 30, 2016 11:52 a.m. ET
The world oil market is starting to resemble the old slapstick gag about the French Foreign Legion. The sergeant needs a volunteer to take a step forward for a dangerous mission. Instead, all the assembled soldiers, except one, take a step back, volunteering him.
The sucker this time seems to be U.S. shale. While Russia and many members of the Organization of the Petroleum Exporting Countries may meet next month in Qatar to discuss the idea of an output freeze to support prices, this represents a hollow pledge. Yes, the invited countries represent some three-quarters of global output—certainly enough to move the needle on supply. But that needle is stuck in the red zone for all but one producer.
Iran, coming off of years of sanctions, is determined to ramp up its output to some 4 million barrels a day from about 2.9 million in January. In the face of that commitment, regional rival Saudi Arabia is reluctant to cede market share. And Russia, pumping near post-Soviet records and desperate for income, has taken a similar stance.
Photo: The Wall Street Journal
With OPEC and its possible partners unwilling to agree to anything beyond the status quo, balancing of supply and demand is being done by western producers with bills to pay and shareholders to please. Economics might seem to dictate that the first cuts would come from the highest-cost fields such as Canada’s oil sands, but that would be wrong. Instead it will occur where lack of investment will show up first: U.S. shale.
A report last week from the U.S. Energy Information Administration highlights why. A surprisingly high 48% of U.S. oil production from the contiguous states came from wells drilled since 2014. The vast majority is from unconventional formations such as shale. They went from providing 500,000 barrels a day in 2009 to a peak of 4.6 million last May, but output has been declining since then as spending was slashed. Based on geology alone, that decline should have been worse. Production from a shale well typically falls by half during the first year in operation and then by another quarter to one-third in the following year. The reason it hasn’t is a significant rise in productivity per well—a modest additional investment squeezed out extra barrels. That trend is reaching its limits, though.
So are U.S. producers really such patsies? Driven by the imperative of profitability, it is true that they will cede share. But a large number of uncompleted wells colloquially referred to as a “fracklog” stands ready to come on stream fairly quickly once prices rise by another $20 a barrel or so.
By keeping its financial powder dry, a leaner U.S. shale patch can storm back soon after prices become more attractive and enjoy the last laugh.