Source: Oil & Gas Financial Journal 20 February 2017
According to Ernst & Young US Energy Leaders, US shale production will serve as a natural cap on crude prices for the foreseeable future, and the resulting compressed price cycles will require oil and gas companies to make significant changes in strategy in order to compete effectively.
Shale plays — through the ongoing application of technology innovations and cost improvements — have disrupted the traditional supply curve.
The industry has always been cyclical in nature, but those cycles have typically been long ones, usually featuring multiple years of higher-than-normal prices followed by sharp drops and long recoveries.
But shale changes the game. Because of its abundance, the number of economically rational operators involved, its short development cycle and its ability to deliver returns quickly, US shale will likely represent the marginal barrel of production, at least in the medium term.
When prices move above the economic break-even point — most likely in the neighborhood of $45–$50 a barrel — US operators will react quickly, locking in the economics via volume hedging, deploying the necessary capital and producing to that volume.
As US shale producers respond to price signals, their time from decision-to-drill to first oil is now around 12 months — compared with the much-longer lead time conventional plays require to come online (and with far less project risk).
With quick ramp-up, US shale production will rapidly close any gaps in supply and keep prices from gaining too much upward momentum. Then, as prices fall again, producers will pull back on drilling — or drill but allow wells to remain uncompleted — until the next supply shortfall. These wells remain in inventory and can cycle back even quicker within a three- to six-month time horizon.
As a result, the oil market clearing price will be set by US shale. This quick response means the commodity price cycle will likely be compressed, compared with historical trends. And we’ll see more time spent in the trough versus the highs.