The Fuse

Key Takeaways from CSIS Shale Event

by Matt Piotrowski | March 02, 2018

Market participants see shale’s growth countering OPEC production cuts and meeting most if not all increases in global demand in 2018.

U.S. shale production has been a key factor dampening volatility and keeping oil prices from rising higher. NYMEX WTI prices consistently above $60 per barrel has led many to revise upward their shale production numbers for this year and next. Market participants see shale’s growth countering OPEC production cuts and meeting most if not all increases in global demand in 2018. At the same time, however, geopolitical outages and declining petroleum inventories could precipitate even higher prices.

Given the importance of shale in global oil markets, the Center for Strategic and International Studies hosted an all-day event this week with a group of experts to discuss the sector and future uncertainties.

Below are some of the main points:

  • Divergence in forecasts. There is wide disagreement on future shale production growth, with 2018 forecasts ranging from 700,000 barrels per day (b/d) to 1.6 million barrels per day (Mbd). The divergence stems from differences over macroeconomic assumptions, price expectations, the supply chain outlook, and productivity projections.
  • Rystad’s bullish outlook. Rystad’s Artem Abramov sees U.S. production surpassing 11 Mb/d in Q4 2018 and 12.5 Mbd in Q4 2019. Output growth should average 100,000 b/d monthly, based on his estimates. “There are so many downside risks which have to materialize simultaneously for this not to happen,” he said. The forecast is based on WTI averaging $65 this year and $61 in 2019. Decline curves have improved “systematically” over the past five to six years, and shale players can absorb significant cost inflation if WTI stays above $60.
  • Technological upsides. Longer-term outlooks also differ between those who expect declines after the optimal drilling locations (the so-called “sweet spots”) are depleted and optimists who see this decline offset by technological advances. Robert Kleinberg of Schlumberger said growth of the magnitude that we have seen this decade will not occur again, but shale can “maintain production in the face of depletion” because of technological advances. Woodmac’s R.T. Dukes thinks Permian production will peak in 2021 unless there are major technological advances.
  • Price and productivity. In the short term, there is significant price elasticity because shale can respond quickly to market changes. Woodmac’s Dukes said: “Small price moves can have great impact on operators.” He added: “The oil price doesn’t just change activity, it changes psychology.” Besides price, another major reason for divergent forecasts is assumptions over productivity. Dukes emphasized that compounding historic productivity rates can be misleading when projecting future growth.
  • Constraints and bottlenecks. The shale industry has to contend with a number of bottlenecks and constraints that could slow production growth. For example, many workers laid off in 2014 are reluctant to return; new equipment takes more than six months to move from order to delivery; and service companies are reluctant to order expensive new equipment. “Some might wait for $80-$100 to expand aggressively,” said Abramov. Trucking and poor road infrastructure are the most significant bottlenecks. For instance, there are now more than 2,600 frac sand trucks on roads in the Permian, but that should rise approximately 75 percent by 2020, adding to logjams.
  • Investor appetite for shale. Jan Stuart of Cornerstone Macro said that the shale sector finally is on the brink of making money. The industry has consolidated, it has a large inventory of good wells, and it can grow and become profitable at $50. Moreover, companies’ balance sheets have improved and global oil markets are now in a supply deficit. Roger Diwan of IHS Markit sees a significant amount of capital ready to fund the sector. Private equity and others are still willing to finance oil and gas in US. The rise in prices last year increased the amount of capital companies can borrow, and investors are drawn to shale because of interest rates are low, it is an asset-backed business, and it can generate cash flow quickly.
  • The old model has broken down. Paul Sankey of Wolfe Research said that shale’s strategy of maximizing investment and production growth and hoping that prices will rise does not work anymore. Previously, oil companies could rely on resource shortages and expectations of stronger prices to generate high returns, and CEO compensation incentivized unprofitable production growth. The current environment, however, is “forcing companies to stop relentless growth because they can’t rely on higher prices in the future,” Sankey said. In contrast to shale companies, which are dealing with disappointed shareholders, refiners have seen the strongest performance in the energy sector despite growing expectations that rising sales of electric vehicles will eventually curb demand for their products. They have focused on returns instead of growth, pleasing shareholders.
  • Can crude exports continue to rise? Foreign markets can purchase more U.S. shale oil, according to Amrit Naresh of ESAI Energy. The U.S. has the potential to ship up to 1 Mbd to Asia in the coming years, in part because of expansion of refining capacity in the region. Between now and 2022, refining capacity will grow by 6.8 Mbd in the Middle East and Asia, with most occurring in China. Interestingly, mid-sized producers in the U.S. now are looking for export outlets, a big shift from the traditional process of selling to the closest refinery. The biggest threat to U.S. crude exports is a rebound in production in Libya and Nigeria, two countries in OPEC that are not subject to quotas.

Even though more analysts are confident the sector can turn a profit in 2018, it is not guaranteed.

If there is any consensus surrounding shale, it is that production will grow in the near term, even if forecasts vary widely. But even though more analysts are confident the sector can turn a profit in 2018, it is not guaranteed. Shale companies will have to impose the necessary stricter discipline because the current trends of increased, high debt levels, and negative cash-flow are not sustainable. The sector will also, of course, have to contend with OPEC action moving forward and the group’s partnership with Russia, as any changes in policy will have an outsized impact on the outlook for shale.