- MIT study: EIA focuses too much on technology & overstates future growth from shale.
- Share prices for shale E&Ps down on average 20 percent in 2017 despite higher oil price.
- “Sources of capital are being squeezed, and that means lower [production] growth.”
Shale has upended global energy markets but two questions remain unanswered: Can it be called upon to meet demand growth, and will it ever be profitable? A recent major study on shale’s geology and investor frustration with the sector point toward increasing difficulties in the future for shale, and the global oil markets.
Research from the Massachusetts Institute of Technology (MIT) sheds some light on the future of shale, and the problem of seeing it as a panacea to stabilize the global oil market over the long run. MIT’s study (see here for an explanation of its methodology) highlights a fault in the Energy Information Administration’s (EIA) longer-term forecast and says it is too optimistic. The authors suggest that the EIA has overstated how improvements in technology have increased output. The agency’s focus on technology has contributed to it overestimating shale growth for the future.
Well productivity gains stemmed from “changes in where companies were drilling wells rather than how they were drilling them.”
In their research in North Dakota’s oil fields, authors Justin B. Montgomery and Francis O’Sullivan discovered that half of average well productivity gains stemmed from “changes in where companies were drilling wells rather than how they were drilling them.” While prices have been low over the past few years, drillers have focused on “sweet spots,” allowing them to extract as much as possible from these easier-to-find areas, and this factor has not been sufficiently included in government forecasts. Drilling in sweet spots provides strong profits in the short run. However, supply will eventually be constrained as producers deplete these areas.
The EIA sees, in a number of its different long-term scenarios, U.S. production continuing to rise until the end of next decade before declining. In its “High Oil and Gas Resource and Technology” case, the most optimistic scenario, the agency says U.S. production could hit 17.2 million barrels per day (mbd), an 80 percent increase versus today.
“There has not been a rigorous attempt to disentangle the effects of technology and sweet-spotting.”
O’Sullivan and Montgomery say that production from oil wells in the U.S. could end up 10 percent weaker than EIA’s estimate for 2020. The situation may deteriorate deeper into next decade as sweet spots are depleted and technology improvements are not sufficient to bring output gains. “There has not been a rigorous attempt to disentangle the effects of technology and sweet-spotting,” said Montgomery earlier this year.
Stagnant productivity, investors flee
Thanks to shale, total U.S. crude production hit 9.7 mbd last week—up from 8.8 mbd at the start of the year—and is forecast to average just under 10 mbd for 2018. Producer hedging has accelerated in recent months as U.S. crude futures have traded in the mid-$50s. This has allowed drillers to lock in guaranteed prices for the year ahead.
Rig productivity has continued to stagnate in the major shale basins in the U.S.
Despite these positive indicators, a number of signs point to current trouble in the shale industry.
Recent data shows that rig productivity has continued to stagnate in the major shale basins in the U.S., highlighting the limited upside of U.S. production. Productivity in the Eagle Ford, for example, peaked at 1,617 barrels per day (b/d) from a new well in October 2016, falling to just 1,124 b/d per rig per well this month. In the Permian in West Texas, the hottest area in shale oil, productivity is now 586 b/d, down from the high of 727 b/d in August 2016. The Permian is seen by some in the industry as the main factor keeping prices low in the next decade, with one former shale CEO suggesting production there could reach 10 mbd, up from 2.7 mbd now. One other indicator of difficulty is drilling time per well, which fell for several years but is increasing in certain areas, and may not continue to fall overall. At the same time, some efficiency gains that stemmed from changing drilling techniques have mostly reached their limits.
Sector-sustaining investors fed up with poor performance
There are also questions of the overall financial health of the shale sector. The industry has never been self-sustaining. Companies have had to borrow heavily because they do not generate positive cash flow. Now, investors are fleeing shale companies. EPFR Global, cited by the Wall Street Journal, said that $800 million has exited energy-focused equity funds so far this year. By contrast, there were inflows of $6 billion in 2016. Share prices for shale E&P companies are down on average 20 percent in 2017 despite the S&P 500 seeing returns of 17 percent and the oil price rising by a third since June. Since 2007, shale companies have spent $280 billion more than they have generated.
Since 2007, shale companies have spent $280 billion more than they have generated.
Investors have become impatient with companies’ strategy of growth instead of focusing on maximizing returns. The Wall Street Journal reported that a group shareholders in U.S. shale producers met in New York City in September to discuss ways of putting pressure on companies for increasing capital discipline and to become profitable. This meeting is a sign of investor frustration and shows how the shine has worn off of the industry. Investor pressure could force changes in strategy and negatively impact production.
“A lot of companies have failed to meet expectations,” an energy investor told The Fuse. “They’re not making as much money as originally thought with prices at this level.”
“Companies relying on capital markets are giving it second thoughts. Sources of capital are being squeezed, and that means lower growth,” he said, adding that investors are looking to other sectors, such as tech, for better returns.
Against the backdrop of subdued expectations for shale, it’s becoming more apparent that global oil markets could be facing a supply shortage in coming years. Oil market experts last week emphasized the need for larger conventional projects in the next couple of years to moderate oil prices in the light of shale’s limited upside. Global oil markets will need approximately 40 mbd in the next six to eight years to offset natural declines and meet demand growth.
Against the backdrop of subdued expectations for shale, it’s becoming more apparent that global oil markets could be facing a supply shortage in coming years.
Given the daunting challenges on both the supply and demand sides in the coming year, it’s important that researchers, analysts, forecasters, and market participants provide sober assessments for the future. Forecasters failed to predict the shale boom at the beginning of this decade, and as they caught up to the surprising growth, they may be erring on the side of overestimating its potential. “[MIT’s] research should help both policymakers and commercial entities better understand what can be expected from these important resources going forward,” says Montgomery.