In late 2014, with oil prices plunging, OPEC members met in Vienna and decided to let them keep falling. What ensued was a global game of chicken. While the falling prices would—and did—hurt OPEC countries, the cartel’s leaders believed the price decline would hurt upstart U.S. producers even more.
The costs of hydraulic fracturing were too high, they reasoned, and as prices fell, America’s nascent influence on global oil prices would be over before it started.
Things didn’t quite work out that way.
Prices plummeted to less than $30 a barrel from more than $100, and U.S. production did slow. By last September, it dropped to about 8.6 million barrels a day from a peak of more than 9.6 million in April 2015, but we were still producing seventy percent more oil than we averaged eight years earlier. Fracking proved more resilient than OPEC thought.
In November, the cartel changed tactics. It reached a deal among its members and with non-OPEC countries, such as Russia, to cut their combined output by about 1.8 million barrels a day, pushing oil prices above $50 a barrel, where they’ve stayed ever since.
In late January, the Saudi oil minister, Khalid al Falih, brushed off any suggestion that frackers in Texas or elsewhere in the U.S. would once again undermine OPEC’s strategy. Don’t think that U.S. producers will significantly increase their oil output just because prices appear to have stabilized, al Falih told the World Economic Forum in Davos, Switzerland.
Sure, production has crept up in regions like the Permian Basin, where getting oil out of the ground is cheap compared with other parts of the country, but that doesn’t mean the U.S. will produce enough to influence global prices.
“My expectation is that costs will creep up,” al Falih said. “The supply industry has been decimated. They have been targeting the most prolific areas.”
Rex Tillerson apparently sees things differently. In his last deal as Exxon Mobil’s CEO—before heading off for his confirmation hearings as President Donald Trump’s Secretary of State—Tillerson cut a $6 billion deal to buy prime acreage in the prolific Permian Basin from Fort Worth’s billionaire Bass brothers.
Exxon’s bid for the Permian properties, combined with other deals like Noble Energy’s $3.2 billion purchase in January of Clayton Williams Energy, which has large holdings in the Permian’s Southern Delaware Basin, shows that large American producers think they can still make money with prices half of what they were less than three years ago.
Exxon, for example, said it can produce profitably from its newly required reserves at $40 a barrel.
They aren’t alone. The U.S. Energy Information Administration earlier this month increased its overall U.S. production forecast for the year by almost 200,000 barrels a day. That may be conservative, because weekly production data shows U.S. output has grown by 176,000 barrels a day just since the end of December.
The question is whether frackers can keep production growing. Shale wells have an initial burst of production, followed by a decline of as much as eighty percent soon in the first year after they’re drilled. That means wells must be drilled more rapidly than in conventional fields to increase production. In December, production from new wells exceeded the decline rate for the four biggest shale basins—the Permian, the Eagle Ford, the Niobrara in the Rocky Mountains and the Bakken in North Dakota—for the first time since April 2015, a sign that the production slump may be coming to an end.
“Productivity gains have reduced drilling costs and improved producers’ return on investment, encouraging new drilling at lower prices,” Sandy Fielden, the Austin-based director of oil and gas research for Morningstar, wrote in a recent report.
The Saudis can produce oil for about $9 a barrel, the lowest in the world. The U.S. average, by comparison, is about $21 for conventional wells and about $23 for shale wells. But the costs for an average shale well fell by as much as thirty percent between 2012 and 2016, and forecasters expect that to continue as companies fine tune the fracking process to get more oil from each well.
In other words, while OPEC tried to wipe out U.S. shale production by allowing prices to plunge, the American frackers responded by improving their technology and reducing their costs.
As a result, OPEC has essentially put a floor on oil prices, while U.S. producers control the ceiling. Hundreds of wells across Texas and the rest of the country have been drilled but not completed, known in the industry as “DUCs.” Producers are simply waiting for higher prices so they uncork these wells and sell the oil for a profit. So far, the DUC inventory remains little changed, which has helped keep a lid on prices and bring greater stability to the oil markets.
The Permian has led the resurgence because the geology of the basin makes extraction cheaper, and the abundance of pipelines makes it easy to transport oil from the wells. But the Permian isn’t the only oil-producing region of Texas that’s primed for an upswing. The Eagle Ford Shale of South Texas is also showing signs of comeback. Eagle Ford production dropped quickly in 2015, as crude prices fell. But since May, the number of active rigs has inched up by 15, to 47. Fielden estimates that the area needs ten more active rigs to for production to begin growing again.
The Eagle Ford has a couple of other things working for it. In December, President Obama rescinded a forty-year restriction on crude oil exports. The light crude from the Eagle Ford appeals more to overseas buyers than Gulf Coast refineries, which are calibrated for heavier grades. And the Eagle Ford is close to the port in Corpus Christi, which reduces transport costs.
“If U.S. crude becomes attractive overseas, the Eagle Ford is a good contender for that market,” Fielden said in an interview.
The question, of course, is whether it will last. What both OPEC and American producers would like to find is more market stability. But in the U.S., where free markets reign, companies are likely to ramp up production as prices rise. That, in turn, could create another glut and drive prices down again.
If that happens, OPEC and American frackers will be squaring off for round three.