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

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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 1970

Photographer: David McNew/Getty Images

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

Bloomberg

By Bradley Olson, Joe Carroll and Jim Polson

Nov 25, 2014

The U.S. has the most to gain and the least to lose as Saudi Arabia gathers with its OPEC allies this week to discuss thecartel’s response to falling crude prices.

For the oil industry, a significant production cut by the Organization of Petroleum Exporting Countries would lift prices and profits across the board and help finance further U.S. energy innovation. And while a weaker OPEC response — or no move — would put more pressure on energy companies, the industry is increasingly insulated by burgeoning North American output. Either way, U.S. producers already know what they’re going to do: drill on.

“The industry is very resilient, as strong as ever in recent history,” Tony Sanchez III, chief executive of Texas producer Sanchez Energy Corp. (SN), said in an interview. “The technological advances we’ve made underpin virtually everything right now.”

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, poring 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 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.

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.

Domestic Insulation

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.

This week’s OPEC meeting is viewed as the cartel’s most important conclave since 2008’s worldwide financial crisis.

“The U.S. is an energy powerhouse now,” Bruce Bullock, director of the Maguire Energy Institute atSouthern Methodist University in Dallas, said in a phone interview. “Certainly the impact that OPEC has is far, far less than years ago.”

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.

Continued Production

“Shale looks unlikely to be switched off quickly,” said Andrew Milligan, who helps oversee $442 billion as head of global strategy at Standard Life Investments Ltd. “It could be 18 months before we see shale” impacted.

Not so 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 Nov. 27 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. (GS), Morgan Stanley and Wolfe Research LLC.

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.

Lower Stakes

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.

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.

Strong Returns

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. (EOG) 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.

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.

To contact the reporters on this story: Bradley Olson in Houston at bradleyolson@bloomberg.net;Joe Carroll in Chicago at jcarroll8@bloomberg.net; Jim Polson in New York atjpolson@bloomberg.net

To contact the editors responsible for this story: Susan Warren at susanwarren@bloomberg.netCarlos Caminada

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