Shale production has been increasing over the last months, as U.S. producers are looking for revenue increases. They seek to pay off or keep up with their debt and find profits after two years of struggle. They are hoping oil prices will not drop again. However, there are strong signs that shale producers will continue to face an uncertain future, and that the rising costs of shale production may threaten profits and increase the risk of default.
Shale proponents have argued over the last couple of years that the cost of shale production is less than it was just a few years ago because of technological advancements and experience. For them, this is the primary reason shale producers have and will continue to increase production. However, there is a strong argument among some industry veterans that the decreased cost has come mostly from lower prices charged by service providers during the downturn.
If this is true, shale industry economics would dictate that as the shale industry rebounds and increases production, service charges will continue to rise and thus the cost of production will rise accordingly. In other words, in contrast to most other industries, the cost of shale production per barrel rises simultaneous to the increased production—at least within typical levels of production and the current range of pricing.
Increased production would lead to increased costs per barrel, at least until a certain threshold price. Unless the oil price rises high enough to make cost increases bearable, profits may be difficult or impossible in many circumstances. It is possible that any level of the price of oil below $60 would still prohibit long-term profit for most producers.
Investors have reason to be cautious with shale until we can accurately gauge the direction of production costs as production rises.
Also with regard to shale, Harold Hamm, the CEO of Continental Resources (NYSE:CLR), speaking at the Middle East Petroleum & Gas Conference on May 1, once again called for fellow U.S. producers to curtail production, to keep prices from dropping. Of course, U.S. producers are prohibited from coordinating any production increase or decrease, because U.S. law considers this illegal collusion. Other, smaller producers will not listen to Hamm, because they have debts and expenses of their own to pay and need production to pay for it. Hamm has been making these pleas for two years now, but to no avail.
At this point, the best hope for rising oil prices continues to be:
- Ongoing commitment from the OPEC/non-OPEC group seeking to decrease production;
- A massive geopolitical upheaval, such as a potential prolonged power struggle in Venezuela; or
- A tremendous global economic boom that makes demand rise noticeably.