Drill On: U.S. Mantra as OPEC Power Wanes in the Face of Shale

By Bradley Olson, Joe Carroll and David Wethe

Photographer: David McNew/Getty Images

Pump jacks and wells are seen in an oil field on the Monterey Shale formation near... Read More

No matter what OPEC countries decide tomorrow about cutting oil output, U.S. producers already know what they’re going to do: drill on.
As Saudi Arabia and its 11 fellow members of the Organization of Petroleum Exporting Countries meet for what’s viewed as the cartel’s most important conclave since 2008’s worldwide financial crisis, the U.S. has the most to gain and the least to lose.
For the oil industry, a significant production cut by OPEC would lift prices and profits across the board and help finance further U.S. energy innovation. And while a weaker response -- or no move -- would put more pressure on energy companies, the industry is increasingly insulated by burgeoning North American output.
“The U.S. oil industry is going to continue on its growth track whether OPEC comes out with a cutback or not,” Daniel Yergin, vice chairman of Englewood, Colorado-based consultant IHS Inc. and Pulitzer Prize-winning author of The Quest. “As oil prices go
down, the U.S. industry is going up the learning curve and is better capable of coping with lower prices than it would have been two or three years ago.”
The swagger of U.S. producers in the face of plunging oil prices shows the confidence they’ve gained from upending OPEC’s six decades of market dominance with technology that wrings oil from dense rock for prices as low as $40 a barrel. The shale boom has placed the U.S. oil industry in its strongest position since OPEC began flexing its pricing power in the early 1970s.
Investors are taking note, pouring money back into shale producers in the past 10 days after shares fell an average 20 percent since July.

Economic Resilience

Beyond the ability of producers to remain profitable at lower prices, the broader U.S. economy is even less susceptible to whatever course OPEC might take. A shift away from industries like steelmaking and into services such as health care has helped make the economy less reliant than ever on oil and natural gas, according to government data compiled since 1950.
Since the 1973 Arab oil embargo, the first major shock brought about by OPEC coordination, the amount of oil and gas consumed in the U.S. to generate $1 of gross domestic product has fallen 64 percent. The U.S. in August imported an average of about 4.8 million barrels a day of crude and petroleum products, a 24 percent decline from 1986, the year when Saudi Arabia’s market machinations sent prices below $10 a barrel in a crushing blow to U.S. producers.

Energy Efficiency

As the services economy has grown, oil demand has fallen, with the U.S. burning 13 percent less oil in 2013 than 2005. Improvements in fuel consumption mean cars and trucks can travel further on each gallon of gasoline. The nation is 26 percentage points more efficient in terms of the the energy required to generate economic growth than the global average, according to the U.S. Energy Information Administration.
Since the dawn of the shale oil era in 2010, booming domestic production has insulated U.S. prices from global shocks as growth helped assuage fears of supply disruptions in the Middle East and North Africa. When Libya’s civil war intensified in early 2011, Brent crude, the global benchmark, surged 25 percent while the West Texas Intermediate price rose just 18 percent, according to data compiled by Bloomberg.
U.S. producers already are responding to lower oil prices by adjusting their spending to focus on cheaper wells with higher production. As a result, the billions in projected spending cuts next year won’t significantly curtail U.S. output, which is expected to hold at current levels even if prices drop to $70 a barrel, according to data compiled by Bloomberg. U.S. oil fell to $74.09 a barrel yesterday ahead of the meeting.

‘Strong as Ever’

“The industry is very resilient, as strong as ever in recent history,” Tony Sanchez III, chief executive officer of Texas producer Sanchez Energy Corp., said in an interview. “The technological advances we’ve made underpin virtually everything right now.”
It’s a different story for the 12 nations in OPEC, which are at loggerheads over whether to cut oil production to halt the worst crude-market slump of this decade when they meet in Vienna. A modest cut that reins in current production by about 500,000 barrels a day is the most likely outcome, although no action is also possible, according to analysis in the past week by Goldman Sachs Group Inc., Morgan Stanley and Wolfe Research LLC.
“OPEC’s problem this time is it’s dealing with something which is outside of its control -- this growth in U.S. and Canadian oil production,” Yergin said. “It’s one that hasn’t been fully anticipated.”

Disastrous Scenario

No action from OPEC would probably pressure oil prices to as low as $60 a barrel, Paul Sankey, an analyst at Wolfe, said in a Nov. 24 note to clients. That would prove disastrous for countries such as Equatorial Guinea, Chad, Venezuela, Angola and Iran that are dependent on oil revenues to survive, said Mark Schaltuper, head of the Americas research team at Fitch Inc.’s Business Monitor International.
To offset the impact of the U.S. shale boom, OPEC’s leading producer, Saudi Arabia, “would have to take a very substantial cut in supply, which it appears they are not willing to do,” Charles Doran, a professor in Johns Hopkins University’s School of Advanced International Studies, said in an interview.
The stakes are much lower for the wildcatters and global energy giants who have remade North America as a powerful counterbalance to OPEC through technological breakthroughs in brittle rock layers, Canada’s oil sands and ultra-deep reservoirs in the Gulf of Mexico.

Varied Fortunes

Not all companies and oil fields will fare the same if oil prices sink below $70. On average, shale producers in North Dakota’s Bakken and Texas’s Permian Basin formations need prices around $67 and $65, respectively, to make drilling worthwhile, according to ITG Investment Research. And while oil-sands operators can continue producing at $75 a barrel, new projects may be put on hold as companies reassess the economics of lower prices.
Technological progress has enabled producers like ConocoPhillips to turn a profit at prices as low as $50 a barrel in the most productive drilling areas. EOG Resources Inc. would get a 10 percent rate of return in Texas’s Eagle Ford field at an oil price of $40 a barrel, according to the company.
The strength of the prospects of many companies has turned Wall Street more bullish lately. As oil fell 29 percent since June, investors shaved about $150 billion from the market value of shale producers. Now the 44 energy stocks in the Standard & Poor’s 500 are forecast to rise 20 percent in the next 12 months, twice as much as any other industry, according to analyst forecasts compiled by Bloomberg.

Bullish Investors

Hedge funds and other investors poured $1.5 billion into exchange-traded funds holding energy stocks over the week ended Nov. 24, the most of any sector. That’s become a popular, low-cost way to bet on broad stock movements. Money has flowed back into energy ETFs after a September sell-off so that they lead all sectors in fund flows with $6.8 billion added so far this year.
“The U.S. is an energy powerhouse now,” Bruce Bullock, director of the Maguire Energy Institute at Southern Methodist University in Dallas, said in a phone interview. “Certainly the impact that OPEC has is far, far less than years ago.”