Impact of falling oil prices on U.S. shale – what experts say

Falling graph
Source: DollarPhotoClub

When OPEC announced it would maintain its current oil output, which sent West Texas Intermediate prices falling below $70 this month, many doomsayers spelt the end of the U.S. shale boom. But analysts have since come out in defence of the North American shale industry, which might turn out to be more resilient than many give it credit for.

Speaking to Bloomberg, Harold Hamm – the billionaire wildcatter behind Continental Resources – said that he expects a slowdown in exploration activities for a while but he is betting on the recovery of oil prices.

“Will this industry slow down? Certainly,” Hamm told Bloomberg in a telephone interview. “Nobody’s going to go out there and drill areas, exploration areas and other areas, at a loss. They’ll pull back and won’t drill it until the price recovers. That’s the way it ought to be.”

The often overlooked strength of the U.S. shale industry, according to Hamm, is it’s ability to quickly adjust to the changing situation in the market. This separates it from countries like Venezuela, Iran, or even Russia, which bet on profits from oil and gas to balance their government budgets and social spending.

“We can adjust quickly,” Hamm told Bloomberg. “It’s a lot easier to adjust companies than it is for countries to adjust. When you’ve got people starving or social policies within countries that people are used to, it’s hard to adjust those.”

Mr Hamm has said in the past that his company can turn a profit at prices of $50 a barrel.

Meanwhile, the oil giant ExxonMobile has announced that they are not likely to be hit hard by the falling oil prices. Exxon’s CEO and Chairman Rex Tillerson told CNBC on Wednesday that the company could weather the downturn in oil prices even if prices sink to $40 per barrel.

Mr Tillerson told CNBC that he expects the downturn to trigger some shaking out at the margins in a correction, saying that the barriers to entering the oil production industry have been fairly low. He believes, though, that firms which are able to refocus on the basics should be able to weather the storm.

“It really means a return to fundamentals for us,” Tillerson said. “It’s important about watching your cash, watching your investment decisions, being very disciplined about everything, and then looking for opportunities that may present themselves in an environment like this.”

Analysts are not unanimous about where the oil prices will go from here. While Harold Hamm expects the prices to go up, Oppenheimer senior energy analyst Fadel Gheit told CNBC that prices will most likely continue to fall in coming weeks.

“Most likely this is not a bottom. Most likely we’ll see oil prices going lower,” Gheit said Tuesday on CNBC’s “Futures Now.” “The same traders and speculators that took oil prices from $95 to $70 will also be able to take oil prices from $70 to $60, or even $55.”

Gheit said it’s difficult to put a number on the bottom, because “once you get to a certain level you are going to see a lot of speculation. Speculation usually overheats oil prices on the way up, and really brings them down hard on the way down.”

Having said that, Gheit expects that any dip into the low $60s or high $50s will be “very short term,” lasting “a week or two at the most.”

Despite the media frenzy around the falling crude prices, the message from most analysts seems to be ‘don’t panic’.

“If we get swayed by the moment, you’re like the proverbial ball in a pinball machine bouncing around,” said David Mahmood, chairman for Dallas-based Allegiance Capital Corp; an investment bank specialising in mergers and acquisitions. “That isn’t a good way to try to run your business.”

Speaking to Houston Business Journal, Mr Mahmood compared the current situation to what happened with natural gas prices in late 2008. At that time, new shale production caused a glut of natural gas in the market, sending prices tumbling.

As a result, the companies which heavily invested in natural gas were hit quite hard. Chesapeake Energy had to cut jobs and it drove Dallas-based Energy Future Holdings to bankruptcy. But there were winners as well. Any time there’s a downturn, stronger companies can buy up distressed companies cheaply.

At the moment, the winners are petrochemical plants that benefit from the rock-bottom prices of feedstock. New plants are being build along the Texas coast as we speak. The U.S. manufacturing sector is experiencing a renaissance that hasn’t been seen for decades. A report published in April argued that U.S. manufacturing is on its way to becoming more competitive than China’s.

However, it is true that the manufacturers’ boon is the drillers headache. Upstream companies will have to scale down their investments in the face of falling prices.

An IHS report published last month claims that the fall in crude prices will have a negligible effect on tight-oil production since the highest costs are associated with the initial development phase of a well. Where the squeeze will really be felt is the production growth, because new wells require significant amounts of investment to bring them to production.

This seems to be borne out by the most recent statistics. According to data provided exclusively to Reuters on Tuesday by industry data firm Drilling Info Inc showed 4,520 new well permits were approved last month, down from 7,227 in October.

Sources: Bloomberg, CNBC, Houston Business Journal, Reuters

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