Increased Oil Competition: Survival of the Fittest

Is the U.S. shale oil industry in trouble? No, it is engaged in a high-stakes competition for market share. As oil flooded the market in 2014-15, prices dropped dramatically and producers began burning midnight oil to manage the downward economic pressures. While some overleveraged companies won’t survive the economic challenge, in true Darwinian fashion, the fittest will prevail.

According to the U.S Energy Information Administration’s (EIA) “Drilling Productivity Report,” it is estimated that by January 2016, daily production in the seven most prolific shale oil and gas areas in the U.S is expected to fall by 116,000 barrels of oil and 365 million cubic feet of gas. Those seven production areas—ranging from the Utica and Marcellus shale deposits in the Northeast and the Bakken, Niobrara, Haynesville, Permian, and Eagle Ford deposits in the middle of the country—accounted for 92 percent of domestic oil production growth and all natural gas production during the years 2011-14.

The decline is directly attributable to a 2014 decision by the Organization of Petroleum-Exporting Countries (OPEC) to produce without regard to market supply. Consequently, a barrel of Benchmark Brent crude oil that brought $114 in June 2014 today brings under $40. OPEC members, particularly Saudi Arabia, can afford the lower price because they can pump oil for as little as $15 a barrel –a competitive advantage American producers cannot match.

In December, OPEC doubled down on its strategy and oil prices hit a seven-year low. The lower price hits OPEC profits too, of course, but the greater harm is done to competing oil producers with higher production costs. Those companies can only stop producing and exploring. Many will fail altogether.

So far, some 250,000 job losses around the world are attributed to the lower prices, about 79 percent of that in oil field-service companies like Schlumberger and Halliburton. Swift Worldwide Resources speculates that more than 10,000 workers have been let go by struggling independent contractors and subcontractors. In keeping with their independent status, such companies typically don’t announce layoffs.

The glut of oil has affected shale oil field operations—OPEC’s primary target—with the number of oil rigs in North America declining 62 percent from December 2014, according to WTRG Economics. Some shale oil producers with high production costs are going bankrupt, while other producers are, in the words of an Oxford Institute for Energy Studies report in November, “[going] into hibernation” or otherwise adjusting as needed.

Many companies are creating different survival adjustments include selling off assets, such as pipelines, to private equity investors, — part of Chesapeake Energy’s strategy– “refracking” wells using newer technologies, and using multi-pad drilling with “walking rigs” that are moved from hole to hole on a single site. Well-endowed companies are shelving Arctic megaprojects (e.g. Royal Dutch Shell) or getting out of deepwater drilling altogether (e.g. ConocoPhillps) in favor of shale oil production. ExxonMobil has drilling rights to 1.5 million acres in the Permian Basin shale formation and in October was looking to acquire more.

As the OPEC challenge continues, producers are implementing ways to keep their heads above water. Many producers are downsizing their employees and finding cost effective means for continual oil production, however despite the temporary strategies that are in place, it is not certain who will survive.

Energy Collective