Less than $50 for a Brent crude barrel – so, what about the shales?

Brent crude price fell below USD 50, for the first time since 2009. The low price is good for oil importer countries, but a nightmare for oil producing companies.

Oil majors, national corporations (e.g. Pemex or Rosneft) and small oil companies are used to oil price variations and adjust their upstream capital investment policies accordingly. However, a sharp decrease in the price of oil that more than halved over the past six months was unforeseeable and could not be offset in any way.

With OPEC in chaos, oil producer countries increasingly competing with each other and falling demand from China and Europe, there are no prospects for a rebound of oil prices in  the near future. This is further substantiated by the decision made by Saudi Arabia on 5 January (just before the Epiphany, which explains why it went almost unnoticed in Poland) to reduce the price of oil exported to Europe and the USA.

The Saudi's decision and OPEC countries' inability to reach a consensus, due to Saudi Arabia's policy, hit more than just the revenues of OPEC member countries. Small and medium companies that have to rely on debt in order to fund their E&P projects have been hit the most by the low price of oil. This is also true for companies that operate in Poland.

The rate of return on particular projects is contingent on the price of oil. If the price falls, some projects generate no profits, their value is down, the cost of finance is up and new projects are not launched. The financial standing of the companies may be at risk. This is the case of the so-called independents who operate in a large number in the USA. Many of them are shale gas producers. They are behind the successful development of the oil and gas sector in North America so that the USA have been able to reduce markedly their oil imports with direct effects on the global price of the crude.

As early as at the turn of August 2014, when the price of crude fell below USD 100, the upstream funds, banks and investors from the sector considered the situation as acceptable. When oil barrel price fell to USD 80 USD (early in November 2014) some analysts began to raise the issue of break even point below which shale oil or gas production would be no longer profitable. Various figures were bandied about: USD 80, USD 70,  USD 69, USD 60, and even USD 50 or USD 40 per barrel.

The latest news from London mean that shale projects, even the most productive ones, are at the verge of profitability. Investing in new wells is a must in order to maintain shale oil and gas production. As much as 50-60% of recoverable reserves may be recovered in the first year of production. The existing wells will continue to produce hydrocarbons, but in the absence of new wells the overall volume of production will decrease as early as the second quarter of 2015. On the “micro” level, this may mean spectacular bankruptcies in the shale sector.

Potential bankruptcies of small players in the USA would not mean a demise of the shale revolution, bringing back high oil prices as a result of reduced supply from US fields. The shale sector has learned its lesson well: production efficiency is up, a better knowledge of geology and improvements in fracturing technology brought the costs down and clearly enhanced profitability of shale gas and oil projects.

Moreover, the shale revolution brought about a scale of operation that can be restored as soon as the oil prices rebound. A whole shale development industry, from service companies to lawyers and investment funds, is now established in the USA. Even if many companies go bankrupt, the human capital will be there and the price of oil will not fall forever. Despite the oil price collapse, some of the shale projects will continue to produce oil and gas.

Cyclic ups and downs of oil price are a normal thing. Therefore, the Saudi Arabia's effort to bring oil price down in order to suppress the US shale revolution (as some believe) may fail. The revolution is already done, whilst the price of USD 50 per oil barrel, whatever the reasons behind its occurrence (speculation, strong dollar, low demand, geopolitics), will only temporarily decrease the supply of unconventional gas and oil.


Antoni Fałkowski

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