Low Breakeven Costs: Are They Really Good?

on April 18, 2017 at 1:10 AM

Breakeven oil prices have fallen below $40 per barrel as of late – a trend that some analysts believe on applies to shale companies, such as Devon Energy and EOG Resources. However, new data shows that even the big players, the major oil companies, have reached the same breakeven levels.

These shale companies (also known as tight oil companies) have often been portrayed as unique with regards to cost reduction. But recent filings with the SEC proves differently.ExxonMobil

In addition to tight oil companies having reached low breakeven points, the large companies (ExxonMobil, ConocoPhillips, ChevronTexaco, etc.) all reached a breakeven of less than $40 per barrel – something of an enigma to many analysts.

The SEC filings include what is known as the “standardized measure”: a projection of future cash flows (net) that would come from the production of oil from proven oil or gas reserves. These projections are discounted by 10%. This “standardized measure” can be divided by the volume of the proven reserves to reach a per-barrel cash flow number – how much cash flow can be produced from a single barrel of oil. Subtract that from the average price for the year, and the breakeven price is reached.

But the question remains: how is it that the gargantuan oil companies that have dominated for decades have breakeven prices comparable to the much smaller and nascent shale companies? Art Berman, a Forbes contributor, attempts to answer this question. This phenomenon is due to costs falling for everyone – the limited number of projects forced oil field service companies to work at a loss, which inevitably drove costs downward. This has been a trend since 2014.

Between March of 2014 and January 2017, the oil and gas well drilling producer price index fell 45%.

Some believe that unconventional oil and gas should be considered low-cost. However, unconventional oil is what caused a 400% increase in the cost of drilling between 2003 and 2014 – that’s why oil was hovering above $90 per barrel before prices sharply fell.

Simply put, this evidence may indicate that technological advances are not the drivers of low energy prices.

There is a downside to lower breakeven prices, however: in the future, companies will make less money. These companies, in compliance with regulation, must write down reserves that have developments costs higher than their market value – this happens more frequently at lower oil prices. Indeed, data shows that as costs were reduced between 2014 and 2016, future net cash flows were also reduced – by two-thirds in 2016.

Writing down reserves with poorer performance is simply another manifestation of high-grading – the process by which oil companies pour funds into their best performing assets. The low breakeven prices have been brought about because only the most profitable reserves are included in the calculus. Moreover, the costs associated with these assets – taxes and property and equipment costs – are removed from the final calculation of cash flows when these assets are written down.

This is not to discount the improvements that have been made in technology and efficiency with regards to drilling. However, these improvements may not have a cause-and-effect relationship with falling breakeven prices. Those who support this view say we should be lamenting the loss of future cash flows, rather than celebrating the low costs being realized today.