Low Oil Prices Ahead as Fracking Breaks Even at $25/Barrel

The U.S. Energy Information Administraiton (EIA) has released a Drilling Productivity Report (DPR) that shows the U.S. drilling rig count in the four major “tight-oil” regions of the Permian, Eagle Ford, Bakken, and Niobrara fields fell 32%, from their October peak of 1160 to 780 rigs. However, despite a 65 percent crude oil price decline and the rig count at the lowest level in almost four years, the EIA predicts that production from these four regions  is 500,000 barrels per day higher than in October. That translates to a $25 per barrel break-even price, meaning U.S. crude oil prices will remain low.

Since hydrocarbons are lighter than water, they migrate upwards due to buoyancy. Their movement is stopped when they reach a low permeability layer of rock that forms a “hydrocarbon trap.” The U.S. boom is about artificially fracturing shale to provide a flow path for that oil. So far, the U.S. is the only country with significant oil and gas shale production.

The six largest U.S. “tight-oil” producers’ costs for exploration, production and non-income-related-taxes are about $25 per barrel of oil. That very low break-even point does not include some companies’ huge interest or principal debt payments and/or the huge profits they have made from using derivatives to sell future production at higher prices.

Creditors want oil companies to continue production until the oil price falls below the break-even cost. That explains why the contract price at the well-head for North Dakota’s Williston Basin Sweet (low sulfur) is only $27.19 per barrel.

Historically, oil consumption falls in a recession and rises in an economic expansion. But U.S. consumption fell last year, despite GDP rising and an oil price collapse. That explains the shocking growth of U.S. crude oil inventories over the last nine months.

Inventories grew last week by a spectacular 10.5 million barrels, versus a 5 million barrel build expected by the American Petroleum Institute. At 65 percent of capacity, inventories are at their highest point in U.S. history. It is expected that capacity will be completely full within 90 daysm and any further surplus must be liquidated.

The latest Drilling Production Report indicates an interim peak in American “tight-oil” production should be expected next month.

Closing down production at a vertical oil well usually results in substantial “stoppage of the pores of the oil-bearing rock.” That reduces “bottom-hole” pressure that forces oil up through the well tube to the surface and limits the future well production capability.

But since shale producers inject water and solvents to free oil from shale and create their own pressure to push oil up through a cement-lined casing, shale wells can be capped and uncapped with virtually no future production loss. Drilling rigs will not vanish and a labor force can be re-assembled rapidly anytime the price of crude oil rises.

From an annual low of $1.21 a barrel in 1970 to an annual high of $108.90 in 2012, OPEC, through member-restricted production quotas, has tried to bleed its customers to the fullest extent. Although the current $44.77 price may seem shockingly low, it is substantially higher than the average of $32.75 per barrel average since 1973.

For the forty years after the 1973 oil embargo, the OPEC cartel punished the economies of its customers at will. But OPEC’s greedy strategy over the last decade created incentives that powered the U.S. shale oil production boom.

OPEC is now facing an epic structural shift in pricing power, in which production cutbacks to force prices up will only incentivize more American production. Low prices are ahead.