A Brief History Of The Shale Oil Boom

In my previous article – Syria’s Impact On Oil Prices – I discussed one of the questions I was frequently asked at last week’s Wealth Summit. To summarize, there will not be much impact on crude oil supplies, but the market fears uncertainty.

But I also talked about Black Swans in the oil industry, and how they tend to rapidly drive oil prices higher. One exception to this rule was the U.S. shale oil boom, which very few people saw coming a decade ago. The net result was that this boom added about 6 million barrels per day (BPD) of U.S. oil production to the markets from 2008 to 2015. This rapid production growth eventually outran demand growth, and that began to manifest itself as growing crude oil inventories around the globe. I captured this in one of my presentation slides:

The saving grace for the oil market up until 2014 was that crude oil demand was growing at an average of around 1.3 million BPD, so in the early stages of the shale boom, the new production merely helped meet growing demand. But then the U.S. added another 1.2 million BPD of supply in 2013, and a record 1.7 million BPD in 2014.

Starting in early 2014, the market became oversupplied for nearly two years, leading to a significant inventory build (shown by the left circle in the slide). I could see the handwriting on the wall, so one of my 2014 predictions was that crude oil prices would fall.  It took another six months after I made that prediction, but surging inventories finally dropped crude prices below $100/bbl. As the price dropped – and inventories continued to swell – OPEC made a decision to defend market share against the upstart shale producers. In 2015 the U.S. added another one million BPD to the market, but OPEC responded by adding its own 1.6 million BPD contribution. 

From 2014 to 2015, about three million BPD was added to a global market that was only growing demand at about half that rate. Record global inventories resulted, and the price of crude oil fell all the way into the $20s. Low oil prices put a lot of shale oil producers out of business, but it also made many more efficient. They got better at squeezing oil from those wells. They squeezed suppliers and optimized drilling techniques. Breakeven costs fell.

OPEC had miscalculated. It was widely believed that $60/bbl oil would decimate the shale oil industry. It did not. Oil producers that had struggled to generate positive cash flow when oil was $80/bbl were now claiming breakeven costs of $50/bbl. Shell recently claimed that their newest wells in the Permian Basin could break even at $20/bbl.

Finally, OPEC blinked. The group decided last November to switch back to a strategy of supporting prices by cutting production. Its experiment to drive shale oil producers out of business had failed. Now, the question becomes whether they can succeed by cutting production. Doing so will prop up prices, which certainly helps OPEC, but it also helps shale oil producers. They are going to make up for part of OPEC’s production cuts.

How much will they make up? That’s the fundamental question. If they offset OPEC’s cuts, then OPEC’s strategy may fail. They may find themselves having to make multiple production cuts to keep prices propped up. So they will lose market share to maintain price. But the alternative for them may be worse, and that’s to dump more crude oil on the market to drive out competitors. Given that this strategy recently failed and caused the cartel a tremendous amount of money, I doubt they will be anxious to repeat that strategy anytime soon.

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