Saturday, October 24, 2015
US shale on its last legs?
Much has been made about the impressive gains in efficiency and productivity in the shale patch, as new drilling techniques squeeze ever more oil and gas out of new wells. But the limits to such an approach are becoming increasingly visible. The U.S. shale revolution is running out of steam.
The collapse of oil prices has forced drillers to become more efficient, adding more wells per well pad, drilling longer laterals, adding more sand per frac job, etc. That allowed companies to continue to post gains in output despite using fewer and fewer rigs.
However, the efficiency gains may have been illusory, or at best, incremental progress instead of revolutionary change. Rather than huge innovations in drilling performance, companies were likely just trimming down on staff, squeezing suppliers, and drilling in the best spots – perhaps all sensible stuff for companies dealing with shrinking revenues, but nothing to suggest that drilling has leaped to a new level of efficiency. Reuters outlined this phenomenon in detail in a great October 21 article.
There is nothing new under the sun. The combination of sustained high oil prices and a US Federal Reserve that kept interest rates too low for too long conspired to allow for a bubble in shale oil and gas. Based on some of the data we have seen recently the whole thing was a big bubble that has popped. There are no efficiency gains and there will not be cheap oil as far as the eye can see. US production will continue to decline until an equilibrium price is reached. This will be the price that shale oil can be produced at that allows a decent return on capital. From what I have seen recently very few if any companies involved in the shale bubble even had positive cashflow much less a decent return. Investors and bankers will be reluctant to lend billions of dollars to exploration companies having been burned once already. This will put OPEC and Russia along with any other private companies that have cheap reserves back into the drivers seat as far as prices are concerned. I still think this is a good time to buy Russia as it remains cheap and will be a direct beneficiary of any increase in oil prices. I have several decent oil speculations in the portfolio and I expect to add a few more soon. One cannot time the exact bottom but we know that history shows that the cure for low prices is low prices which will drive out the high cost producers. Oil is vital to civilization itself and demand will continue to grow especially in emerging and frontier markets as they industrialize and urbanize. In my view well placed bets now will yield tremendous returns over the next several years.