U.S. oil production seen as a moderating force in coping with oil market price volatility

Energize Weekly, May 29, 2019

As costs come down for producing oil from shale plays, U.S. production appears to be playing a larger role in anchoring long-term oil prices, according to a Federal Reserve Bank of Dallas analysis.

The combination of shorter lead times between drilling and production and the falling break-even price—the price at which it is profitable to drill a well—are creating a situation where U.S. production is serving as a break to market volatility.

“These represent strong forces that should keep long-dated futures prices from rising too high or falling too low,” the analysis said.

The average break-even price is down 4 percent in the last year, about $2, to $50 a barrel, according to the Dallas Fed Energy Survey.

Within the Texas oil-drilling regions, there is variation in break-even prices with prime shale drilling areas, such as the Midland and Delaware basins in the Permian Basin, generally posting a lower threshold price.

The survey found the break-even price ranging from $48 a barrel in the Midland and $49 a barrel in the Delaware to $54 in other parts of the Permian. The break-even price also varied among operators from a low of $23 a barrel to $70 a barrel.

The Dallas Fed analysis noted that a Bloomberg New Energy Finance break-even study found prices in the Permian ranging from $46 a barrel in Loving County to $87 a barrel in Reagan County. “The wide variability is largely driven by the quality of the rock, with wells in Loving County typically producing at higher rates and lower costs relative to Reagan County,” the Dallas Fed said.

“Horizontal drilling and hydraulic fracturing have made accessible significant amounts of oil reserves previously considered uneconomical to develop,” the report said.

The analysis also found the cost curves, which show price relative to production, are flattening. If the curves are steep, then a much higher price is needed to increase production by relatively small amounts.

A flatter curve indicates the much more production can be brought online with little in the way of a price increase. The analysis shows the Permian cost curves flattening between 2009 and 2017, when very little in the way of a price hike was needed to go from 100,000 barrels oil equivalent (boe) per day in production to 35,000 barrels boe a day. The oil equivalent calculation takes into account natural gas and natural gas liquids, as well as oil.

“Given current market prices, U.S. shale production will continue growing this year,” the analysis said. “Indeed, a recent report by the International Energy Agency highlighted that shale production is likely to be a major driver over the next five years. This does not rule out the possibility of major oil price movements, but it does point to a strong tendency that oil prices will be range bound in the near future.”

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