Alarmist media reports regarding oil’s foray into bear market territory could easily leave you thinking the oil industry is gasping its last breath. It certainly is not, as companies involved in the global oil complex are accustomed to commodity price volatility and most have experienced similar, if not worse, market corrections.
In fact, over the past few years the oil market experienced an uncharacteristic lack of volatility, with global benchmark prices trading in a fairly tight range.
That said, market dynamics have shifted with North America leading non-Opec production volumes to historic highs. This has led Opec to act differently than in the past when the producer group collectively cut output to stabilize oil prices. Apparently, there is currently too much excess supply in the global market for Opec to favor that strategy. Alternatively, the cartel seems prepared to let prices fall until the world’s highest cost producers are forced to cut production.
This leaves many speculating about US unconventional oil production breakeven levels. However, the highest cost North American oil production operations can be found in Northern Alberta’s oil sands. And globally, some of the more complex deepwater fields are likely more expensive to operate than much US shale activity.
Additionally, trying to find a single magic price needed to sustain US shale resource development is a fool’s errand. On the natural gas side, “Some wells are profitable at $2.65 per thousand cubic feet, others need $8.10…the median is $4.85,” according to Ken Medlock, Senior Director of Rice University’s Baker Institute Center for Energy Studies. The situation is quite similar in US light tight oil plays.
In statistical terms, “the central tendency of distribution matters.” Operators have portfolios of wells and the average production cost gives you a marginal cost, according to Medlock.
“Prices aren’t low enough to put these projects at risk,” Matthew Jurecky, head of oil and gas research for the London-based research company GlobalData Ltd., said by e-mail yesterday from New York. “The profit margin on most commercial unconventional oil plays will support prices as low as $50, many below that even.” – As reported by Bloomberg
Every company has their own internal hurdle rates, hedging strategies, offtake agreements, financing arrangements, along with countless additional factors that go into their drilling strategies. It’s not as if oil prices fall to a certain level and US unconventional oil production stops on a dime. So oil prices would need to fall much further below current levels and remain depressed for several consecutive quarters before significant US output declines would likely be observed.
While current oil price gyrations and shifting market dynamics are intriguing and important, it’s too soon to throw in the towel on US oil development. Look for the highest cost projects to get shelved first. And in the meantime, geopolitical risk remains high and the threat of a major physical supply disruption is always around the corner.
