Shale and a New Normal for Oil Prices – 8/1/16

A lot of talk has been made about a new normal in crude oil prices, most of it tied to the fracking revolution that has unlocked immense reserves of tight oil and natural gas.

Fracking has changed global oil markets, if that much wasn’t already clear from the recent glut that saw oil prices fall over 70% in just a few years. Now that the glut is largely wrapped up on falling production from marginal producers in the U.S., a new quality of fracking is gaining more attention: the unusually flexible nature of fracker output.

Conventional oil drilling is a slog. Oilfields last for decades but take years to develop, so in the past oil output is unresponsive in the short-term. Shale wells, in contrast, exist on the margin of production; they come into being in weeks and last only a few years. As a result, shale-oil supply is much more elastic, rising and falling practically in step with prices which in turn reduces price volatility.

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Now that oil prices are beginning to rise up again, the number of rigs (primarily the quick-to-start fracking variety) are increasing as well. Of course, there is still much more subtlety to the issue. Many in shale-oil were burned when a false rally of prices in early 2015 led to costly decisions to keep output high.

If shale frackers are the new moderating force for prices, then their break-even points are more important than ever in setting the equilibrium for all oil prices. During the glut, shale drillers surprised everyone from Saudi Arabia to Goldman Saches with their ability to survive rock bottom oil prices through efficiency gains and cost cutting.

Data from the EIA shows that U.S.-shale oil drillers continue to bring the equilibrium price lower through reduced costs and higher productivity. Shale drillers have cut the costs of producing new supplies of oil by as much as 40% in the past two years by pushing for lower rates from support service firms. Productivity at the wells has also increased through selective drilling site choices.

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