oil-pumps

After several years of rapid production growth, U.S. shale oil has become a key technology-driven disruptor of the global oil industry. With OPEC flooding the market, shale oil has become the new de facto global swing producer because of the relatively short investment period to first production, steep well declines, and its relatively high cost nature.

Commodity forecasts
2015E2016E
Oil (WTI $/bbl) 50.50 57.00
Natural Gas ($/mmBtu) 2.78 3.25
Gold ($/oz) 1,165 1,200
Copper ($/lb) 2.45 2.50
Corn ($/bu) 3.95* 4.10
Wheat ($/bu) 4.95* 5.10

*Q4 2015 forecasts
Source - RBC Capital Markets forecasts (oil, natural gas, gold, and copper), Bloomberg consensus forecasts (corn and wheat)

As a lower-for-longer scenario for oil plays out, the industry is, by necessity, becoming more efficient. The pressure on producer profit margins has been pushed down to the drilling and completions service providers, with 20%–30% reductions broadly experienced throughout the industry. As a result of this pressure, the break-even costs for U.S. shale oil have moved markedly lower, which is shifting an important component of the industry cost curve downward.

In the currently oversupplied market, oil prices have settled into a rough range of $40–$60/bbl this year. Prices in this range are just low enough to discourage continued shale oil investment in many regions because it is not economically viable. This outcome for prices is not unreasonable so long as the prevailing outlook remains for the industry to be oversupplied for the foreseeable future.

In the longer term, the focus on efficiencies today may have a lasting effect even if the energy services market becomes more balanced or indeed tight. Furthermore, ongoing experimentation with the number of frac stages per well, fluid chemistry, quantity, and type of proppant (e.g., sand) is a secular trend towards lower cost production. The net impact of these two factors is a likely permanent shift lower in the marginal cost of production for a key source of global supply. Shifting the cost curve lower in this fashion is likely to reduce the equilibrium range of oil prices even during periods of more balanced future market conditions.

An approximate range of $75–$100/bbl prevailed for five years leading up to the recent price collapse. With the current view of marginal supply costs for this new swing producer, we could reasonably expect oil prices to remain in a more subdued range of $55–$75/bbl in balanced market conditions, with the potential for spikes on supply disruptions or military action and price lulls during periods of oversupply.

U.S. shale oil break-even supply cost estimates

Source - RBC Capital Markets


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