“There is no question shale plays — through the
ongoing application of technology innovations and
cost improvements — have disrupted the traditional
supply curve...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.”
to a manufacturing process, something the nimble operators
have exceled at exploiting.
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.
Ultimately, US shale will set a natural balancing point.
SHALE STILL ATTRACTIVE
While this may not sound like an exciting business model,
US shale is still an attractive investment opportunity for a
number of reasons.
For starters, the US remains one of the few places in the
world where investors own the rights to underlying resources.
That, of course, incentivizes rights owners to allow drilling
and reduces project risk due to lack of governmental
Second, shale drilling is low-cost, and getting lower. The
typical authorization for expenditure on a shale well is less
than $5 million, and producers continue to peel away significant costs from production while increasing volumes — a
trend that has picked up pace during the recent downturn.
Third, shale drilling has short cycle times, less than two
months in many cases. Some companies have reduced to
fewer than 20 days from start of drilling to production. That
allows shale producers to be much more responsive to market
And fourth, a typical shale well can achieve payback in
approximately 1. 5 years. That significantly de-risks projects
by allowing producers to use hedging to lock in favorable
Compared with offshore wells, for example, shale wells
require less project lead time and less up-front capital expen-
ditures, and cash inflows begin much sooner. And although
shale’s steep well decline rates require additional wells to be
drilled on an ongoing basis, stretching out capex over time
allows producers to adjust the scope of their projects as
market conditions change — drilling more if prices are high
and canceling new wells if prices decline.
Finally, the industry may get a shot in the arm from energy
policies if President Trump holds true to his campaign promises. This could come in the form of regulatory policy as well
as comprehensive tax reform. Companies are well-advised
to retune their legislative efforts as this unfolds.
OPTIONS FOR PRODUCERS
In this new environment, producers that find themselves with
a relatively high-cost portfolio have two options. They can
find ways to take out costs and make existing opportunities
more profitable, or shift a portion of their portfolio to low-er-cost production such as shale.
That latter option may be easier in the longer term. Onshore
drilling inventory in the US today is in short supply, and expensive. Companies can find “great rock” for shale drilling,
but they will pay handsomely for it.
However, as the lower-for-longer price environment adds
stress to the industry, an uptick in transaction activity is
inevitable, and there may be increased opportunity to acquire
shale reserves with favorable terms in the next few years.
Research shows, for example, independent shale producers
with a focus in one major basin have outperformed those
with scattered assets, which may eventually cause some
companies to consider selling or swapping assets to streamline
their operations — providing new M&A opportunities.
Companies currently involved in shale will also need to
change — adopting and refining an operational model that
is better suited to unconventionals, with flexible, timely
decision-making and constant portfolio rebalancing. The
top-down, centrally planned approach that works well for
huge, complex projects hinders shale production and leads
to suboptimal capital deployment decisions.
STEPS TO SUCCESS
Risk mitigation in managing portfolios will be key for conventional oil and gas producers learning to compete in a
world where prices fluctuate from $40 to $60 (and spend
more time at the lower end of that range).
That is especially true for portfolios with large numbers