Now that shale oil producers are replicating the efficiency and effectiveness many showed getting natural gas from rock, will they know when to stop, or will they drive West Texas Intermediate to unprofitable lows as they have done for gas?
Raymond James analyst John Freeman thinks it may be another case of "drill baby drill," with little attention to the market's price signals.
But he points out in a note to clients Monday that his analysis shows that 18 of 20 shale oil plays break even or make 10% profit even at prices below his forecast for West Texas Intermediate to reach $65/b by 2013.
"Plain and simple, E&P producers have become too good at extracting oil and gas" Freeman said. "On the back of seemingly constant improvements in drilling efficiency and well productivity, we must ask ourselves, have we 'drill, baby, drilled' ourselves a little too deep?"
He acknowledges that producers do not live in world driven solely by price: they have pipeline commitments, acreage to hold by production and efficiency considerations that seem to dictate drilling through price troughs.
Nonetheless, oil should not shrug off the lessons of shale gas, he said.
"Natural gas prices have traded below $6/Mcf for more than three years -- and appear to be mired at sub-$4/Mcf levels for another three years," Freeman wrote. "As we now turn our sights to the remarkable surge in domestic oil supply, we must ask ourselves, how low do prices need to go in order to really slow down drilling?"
Of the 20 shale oil plays Freeman looked at (he excluded the Utica and the Tuscaloosa Marine Shale for lack of data), only Oklahoma's Cana Woodford rich gas shale and the Cleveland-Tonkowa in the Texas Panhandle and Oklahoma don't break even at $65/b WTI, although they do at current prices.
The other 18 earn even some minimal return at $65/b WTI, and some, notably South Texas' Eagle Ford oil and condensate shales, earn quite a bit, breaking even at under $50/b WTI.
But the Cushing price is rarely the only consideration. "As prices start to hover at levels where rigs should get 'whacked,' E&Ps are more prone to ride out the storm for what could be perceived as a temporary price drop rather than risk losing efficiencies by dropping a rig and cancelling an already trained completion crew," Freeman said.
"Hedges aren't set in place to protect cash flow from wells that are brought online throughout the year, but rather to stabilize the cash flow of existing production, which provides more wiggle room for capital expenditure and existing drilling plans even when things get dicey," Freeman added. "Lastly, and this should be of little surprise, drilling to hold leases does still exist.
"Ultimately, it remains to be seen whether the industry has learned its lesson from the gas-drilling frenzy, but we're not counting on it," Freeman concluded. "So, while we might not make many Facebook friends in the energy space [with his $65/b call], at least we still have Twitter. #WeWarnedYou."
