Shale Boom Tested as Sub-$90 Oil Threatens U.S. Drillers

By Isaac Arnsdorf

The U.S. shale boom is producing record amounts of new oil as demand weakens, pushing prices down toward levels that threaten to reduce future drilling.

Domestic fields will add an unprecedented 1.1 million barrels a day of output this year and another 963,000 in 2015, raising production to the most since 1970, according to the U.S. Energy Information Administration. The Energy Department’s statistical arm forecasts consumption will shrink 0.2 percent to 18.9 million barrels a day this year, the lowest since 2012.

More supply from hydraulic fracturing and horizontal drilling, and less demand, are contributing to the tumble in West Texas Intermediate crude. The U.S. benchmark is down 24 percent since June 20 and fell below $90 a barrel on Oct. 2 for the first time in 17 months.

“If prices go to $80 or lower, which I think is possible, then we are going to see a reduction in drilling activity,” Ralph Eads, vice chairman and global head of energy investment banking at Jefferies LLC, which advised 38 percent of U.S. energy mergers and acquisitions this year, said in an Oct. 1 interview. “It will be uncharted territory.”

WTI declined to as low as $86.83 a barrel today on the New York Mercantile Exchange, before closing at $87.31, the lowest settlement since April 17,2013. Prices in domestic fields such as North Dakota’s Bakken shale are several dollars lower because transportation bottlenecks raise the cost of reaching refiners.

Lower Oil

The EIA cut 2014 and 2015 crude price forecasts yesterday because of rising production and falling consumption. WTI will average $94.58 next year, down from a September projection of $94.67. The outlook for Brent oil, the benchmark for more than half of the world’s crude, was lowered to $101.67 from $103. U.S. output reached 8.7 million barrels a day in September, the most since July 1986, the EIA said. U.S. demand is down because Americans are driving less and using more fuel-efficient cars, according to the EIA.

Shale oil is expensive to extract by historical standards and only viable at high-enough prices, Ed Morse, Citigroup Inc.’s head of global commodities research in New York, said by phone Sept. 23. Oil from shale formations costs $50 to $100 a barrel to produce, compared with $10 to $25 a barrel for conventional supplies from the Middle East and North Africa, the Paris-based International Energy Agency estimates.

“There is probably something to the notion that if prices fell suddenly to $60 a barrel, the production growth would turn negative,” he said.

Brent crude could drop to $80 a barrel before triggering a slowdown in investment from U.S. shale-oil drillers, Fitch Ratings said in a report today.

Price War

As U.S. supply rises and imports decline, the Organization of Petroleum Exporting Countries may be heading for a price war, according to Frankfurt-based Commerzbank AG. OPEC’s September output rose to a one-year high of 30.935 million barrels a day.

Saudi Arabia, the world’s largest exporter, reduced selling prices on Oct. 1, signaling it is prepared to let prices fall rather than cede market share, according to Commerzbank. OPEC accounts for about 42 percent of world supply, according to London-based BP Plc, Europe’s third-largest oil company.

The SIG Oil Exploration & Production Index, a gauge of the shares of 21 U.S. oil and gas producers, has dropped 19 percent since Aug. 29, compared with a 1.7 percent decline in the Standard & Poor’s 500 Index of equities.

Fewer Deals

“There is some concern in the market broadly that ultimately the chickens of declining demand and increasing supply will come home to roost,” Bobby Tudor, chairman and chief executive officer of Tudor Pickering Holt & Co., an energy-focused investment bank in Houston, said in a Sept. 23 phone interview. Tudor was previously a partner with Goldman Sachs Group Inc.

Capital market transactions that would have been done three or six months ago will probably be postponed because of the downturn, Grant Porter, vice chairman in Barclays Plc’s energy group, said in an Oct. 2 phone interview. Barclays is the biggest adviser to U.S. energy companies selling shares this year, data compiled by Bloomberg show.

U.S. output is rising as companies are now getting more wells out of each rig and more oil out of each well, said Eads, whose team includes 26 technical experts. In the Permian basin of west Texas, the country’s largest onshore field, there are twice as many rigs but five times as many wells, according to Eads.

Each rig in the Permian added a record 171 barrels of new oil a day in October, up 21 percent from a year ago, EIA data show. In the Texas’ Eagle Ford, each rig is getting 536 new barrels a day, up 20 percent, according to the agency.

‘Holy Toledo’

“The thing that blows me away is every day somebody walks into my office with some new project, and I say ‘Holy Toledo,’” said Eads, who was a fraternity brother at Duke University with Chesapeake Energy Corp. co-founder and former Chief Executive Officer Aubrey McClendon. “It’s unreal. We see that once a month.”

Globally, second-quarter consumption grew the least since 2011, according to the IEA. The adviser to industrialized countries cut its demand forecasts last month by 0.2 percent for this year and 0.1 percent for 2015.

The slowdown is “nothing short of remarkable,” the IEA said in a Sept. 11 report. It attributed the decline to slowing economic growth in China and Europe. Higher U.S. production and Libyan exports are contributing to ample supply, the agency said.

Trading Oil

Advances in freeing natural gas from miles-deep shale rocks drove down prices 86 percent in April 2012 from the 2008 high. Prices peaked at $15.78 per million British thermal units in 2005 and dropped to a low in 2012 as shale resources pushed U.S. output to new highs.

Oil prices are harder to move because crude trades more globally than natural gas, according toStephen Trauber, vice chairman and global head of energy at Citigroup in Houston. While oil can be carried on ships, trucks and pipelines, gas has to be frozen before it can cross oceans.

Crude prices might not fall enough to shut in production. About 70 percent of U.S. reserves would remain economic with global prices at $75 a barrel, according to Wood Mackenzie, an industry consultant based in Edinburgh.

OPEC also may prevent further declines because members need high prices to support social spending. Saudi Arabia needs $87.63 a barrel to balance its budget, compared with $66.50 for theUnited Arab Emirates and $92.96 for Iraq, the International Monetary Fund estimates.

LNG Exports

The U.S. has approved four facilities to liquefy gas for exports. While the U.S. prohibits most crude exports, finished products such as gasoline trade freely. Producers are lobbying to loosen the rules for crude too.

The last time the U.S. had a domestic oil boom was in the 1980s, following the Arab embargo. It ended when new supplies overwhelmed the market. Prices dropped to $9.95 a barrel in April 1986 from $32.35 the previous August, and the annual average stayed below $30 a barrel until 2000.

“What always happened is you’d get too much oil and gas and the price gets too cheap and you quit drilling -- can’t make money,” T. Boone Pickens, founder and chairman of BP Capital LLC in Dallas, said in a Sept. 15 phone interview. “You break the price down and you’ll stop the boom right quick.”