First, the American oil sector’s incomparable capacity for initiative-taking, composed of a very wide variety of actors and companies. Among them, a myriad of entrepreneurs, each operating at a very limited geographical scale but with the highest experience on the ground that allows them to take the boldest initiatives, such as the adaptation of horizontal drilling and hydraulic fracturing techniques. The birth of the shale industry in the United States is fundamentally a result of entrepreneurial temperament and risk-taking, far more than any technological innovation. The role of the big oil companies in the development of the shale industry has been secondary or even marginal. Second, at the risk of repeating ourselves to our most loyal customers and readers, we maintain that the monetary and financial context, born of the 2007/2008 crisis and characterized by an abundance of capital and the unprecedented nominal and real interest rates, has been the sine qua non condition for the development and growth of a sector that has never achieved positive cash flows, even in the favorable oil price contexts of close to 100 USD between 2011 and 2014. At the end of 2017, we estimate the cumulative operating loss of the entire sector at approximately 300 billion USD since 2008, or about 8% of the increase in the balance sheet of the FED over the same period.
In the last few months, investors have finally begun to make dissonant voices heard and to demand a change in the strategy of companies exploiting shale oil & gas resources. After the race to grow production at any cost, the priority seems to shift in favor of return on investment. The normalization of the interest rate curve, initiated by the FED but more obvious on long-term interest rates, is not unrelated to this. The rise in interest rates announced by monetary authorities in the United States and in the world is sufficient to gradually change the economic conditions that are at the origin of the oil overproduction phase that was at first amplified, then fought against, by Saudi Arabia and other OPEC producers. But it is possible that the question posed by the shale industry’s decade-long development that ran contrary to the economic fundamentals of the conventional oil industry finds an answer more quickly than under the sole action of the rise in interest rates. Unexpectedly, the tax reform approved by the US Congress on December 22, 2017 contains such provisions. If the reduction in the general corporate tax rate from 35% to 21% is obviously in line with the interests of the oil industry as a whole, the provisions limiting the deductibility of interest charges and removing the ability to carryback net operating losses are undoubtedly negative factors for companies in the shale industry which, still do not generate positive cash flows and are heavily indebted. The combination of these tax reform provisions, the rise in interest rates and the foreseeable increase in production costs following the recent protection measure of the US steel market (key item of equipment and infrastructure costs of the oil and gas industry), announces a profound change, if not an upheaval, in the economic and financial framework of the shale industry. Many small- and medium-sized companies will inevitably be absorbed by large players: “Big Oil” will be the main beneficiary of the ongoing change. But the repercussions will probably be profound. On the one hand, the cost structure of large oil companies is higher than that of small entrepreneurs. The actual breakeven point of the entire shale oil sector is already well over 100 USD, well above the commonly accepted but false values of 50 to 60 USD. All things being equal, the break-even point in shale oil & gas production will increase further. On the other hand, the reduction in the number of small entrepreneurs will reduce the sector’s capacity for initiative-taking, precisely at a time when uncertainties are accumulating about the future potential of source rocks and the existence of sweet spots (the most productive areas).
The oil outlook is changing in the United States in the direction of a stagnation of production and a reality check on real production costs. There are more reasons to doubt than to endorse the IEA’s peremptory assertion that “Over the next three years, gains from the United States alone will cover 80% of the world’s demand growth” (Oil 2018 Report, IEA). In the context of the structural weakness of the potential for conventional oil discoveries worldwide confirmed year after year (Rystad Energy Press Release, 2017), the current consensus of a global oil market characterized by a lasting excess of supply and a low price is called into question.
Olivier Rech, Head of Energy-Climate Research