Oil Tops $50, but for How Long?

Oil briefly touched $50 a barrel on October 3 only to tumble back towards the upper $40s.

The price spike stemmed from an apparent OPEC agreement which aims to cut output to around 32.8 million barrels per day (bpd) from 33.5 million bpd. The details should be finalized in November when OPEC members meet to set its combined output policy.

With newfound optimism running throughout the energy space, can oil really maintain its momentum above $50 a barrel?

North American Shale May Ruin The Party

Let's not forget the powerful force that sent oil tumbling from over $100 a barrel in 2014: North American shale production.
While OPEC has thus far continued to pump at record rates, low oil prices are almost completely due to this new force.

A few years ago, North American fracking created a surprising supply glut stemming from the upstart of thousands of low-cost U.S. shale projects.
Oil Tops $50, but for How Long?
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U.S. imports started to decline dramatically following a big boost in cheap domestic production. Even after a price war broke out—sending prices below $30 a barrel last year—most of these new suppliers continued pumping for far longer than most thought. 

This year investors started to feel some relief when data suggested that U.S. and Canadian crude production was peaking. The curbing of North American supply growth combined with potential future OPEC cuts have been the main forces pushing oil up past $50 recently. However, one of those tailwinds may quickly reverse.

According to a report by the Bloomberg Intelligence unit, projects in the Permian Basin and Eagle Ford (major North American shale plays) can remain profitable even when crude prices fall below $30 a barrel.

A big reason for low costs comes from slow-decline horizontal drilling wells. Areas such as DeWitt County and Reeves County break even at prices below $25 a barrel. Over 80% have break-even production levels under the $50 mark.

Even worse, true production costs may be under $30 a barrel for a huge chunk of shale producers. Drilling constitutes 30% of a well's total cost, so ongoing operating costs are likely much lower than total break-even levels.

With oil entering a new era of lower-for-longer, it's not out of the question that many producers are seeing drilling expenses as sunk costs, instead aiming for profitability based on ongoing expenses.

Shale output has peaked, but due to low costs across the shale universe, it's very possible we see sustainable oil production growth at or even below $50 per barrel.

The recent news out of OPEC has caused oil prices to pop, but ultimately, it'll be North American supply that will move the needle. Conditions don't look promising.

If you're worried, take a look at Hess Corp. (HES): It's using its size to develop attractive projects even with persistently low oil prices.
Published on Oct 3, 2016
By Ryan Vanzo
Ryan Vanzo is the Digital Business and Finance Editor at WebFinance Inc, which runs InvestorGuide.com, InvestorWords.com, and BusinessDictionary.com. You can reach him at ryan@investorguide.com

Copyrighted 2020. Content published with author's permission.

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