Oil Nears $40: Will US Drillers Halt Production Growth?

Crude is spiraling down again, this time it is close to $40-per-barrel psychological mark. In fact, Paul Ciana – a technical strategist at Bank of America Merrill Lynch (NYSE:BAC) – recently said that "Oil is in a downtrend and risks trending into the $30's”.

In the wake of such a scenario where markets are expecting oil exploration and production businesses to run into losses, U.S. shale players have been flocking to crude resources. Crude has lost over 20% on a year-to-date basis but that hasn’t stopped U.S. drillers from pumping out more oil, adding to the woes of an oversupplied market.

It seems that drillers in the U.S. shale plays are cushioned against crude problems and can continue to profit by lowering exploration costs. However, we need to warn investors that the U.S. companies are close to the risk zone and might be compelled to halt production growth if oil slides below $40.

Oil Enters Bearish Territory

Crude slipped below the $45-a-barrel mark on global oversupply worries. On Jun 20, West Texas Intermediate (WTI) crude touched the lowest level since last September. This has questioned the effectiveness of OPEC’s compliance with its landmark production cut deal.

As per the weekly rig count report issued by oilfield services player Baker Hughes Incorporated (NYSE:BHI) , there has been a rise in U.S rig count for 22^nd consecutive weeks.

Higher supply from Libya and Nigeria has also been weighing on crude prices. The countries belong to OPEC but were exempted from the output cut accord. Crude production in Libya surged by 50,000 barrels per day to 885,000 barrels after the dispute between National Oil Corporation (NOC) and Wintershall – energy firm of Germany – was settled, per Reuters. In fact, for the first time since 2014, production level in Libya has crossed 800,000 barrels a day.

Also, per Reuters, the export of Bonny Light crude of Nigeria is expected to touch 226,000 barrel per day during the month of August, much above last July’s mark of 164,000 barrels per day.

News Spells Doom for Shale Drillers

It has been more than three years since mid-2014 that the market has been witnessing weak crude prices. But, U.S. shale companies have never cut down on production to address the supply glut. This has led to the decline in oil.

Let’s analyze the broader factors supporting U.S. firms in their continual drilling activities. OPEC and 11 non-OPEC players, including Russia, decided in the Vienna meeting on May 25, to extend the production cut deal by another nine months. Thus, it is an ideal time for shale players to increase production at the expense of OPEC, especially because oil is trading way above the historical low level reached last February. No wonder, U.S. shale producers have been gathering to oil patches as they aim to sell the commodity at higher prices.

We should consider President Donald Trump’s exit from Paris Climate accord as a factor encouraging drillers to continue pumping more oil.

The question here is how long will the U.S. companies be able to maintain their growth in exploration and production activities amid the crude free fall. In other words, how low will oil have to go before the companies halt drilling ramp up?

Many analysts believe that if oil dropped to $40 a barrel, smaller drillers will be forced to discontinue operations in the comparatively less productive crude resources. Eventually, oilfield service firms like Schlumberger Limited (NYSE:SLB) , Halliburton Company (NYSE:HAL) and Weatherford International plc (NYSE:WFT) will have to lower their activities.

It is to be noted that analysts at UBS Group AG in Zurich predict that most of the shale drillers in the U.S. will suffer at $45-per-barrel oil. If crude touches $40, there will unlikely be any rise in production for all the exploration and production companies in all the U.S. prolific oil plays. Even the Permian Basin, where cost of production is low and infrastructure is readily available, will see a halt in production growth when oil tanks to $40.

Overall, the business scenario is not in favor of companies belonging to the Oil & Gas-U.S Exploration & Production industry. A few such companies are Apache Corporation (NYSE:APA) , Cabot Oil & Gas Corporation (NYSE:COG) and Cimarex Energy Co. (NYSE:XEC) . All these firms carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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