Break-Even Points for U.S. Shale Oil

Photograph: Getty Images

Oil profits are being tested. Crude prices have face-planted to their cheapest level since 2010, threatening the balance sheets of companies and the budgets of nations.

Take Canada’s controversial oil sands. With crude prices teasing $80 a barrel for the first time in years, about 25 percent of the synthetic crude produced from the sands is no longer profitable, according to the International Energy Agency.

Stocks of smaller oil companies, which tend to focus on supplies that are expensive to extract, are getting crushed. Bond holders who have lent to oil prospectors are getting worried they won’t get paid back. But maybe the biggest question remaining is whether the bounty of U.S. fracking, which made America the world’s biggest oil and gas producer, will wither in the field.

The answer so far: not so much. Here’s a list of break-even points for some of America’s biggest shale-oil regions. Note that most regions continue to be profitable below $80, including the Bakken and Eagle Ford formations, two of the most important sources. Much of the Eagle Ford play would still be profitable with $50 oil.

Source: Bloomberg New Energy Finance

Source: Bloomberg New Energy Finance

For the past few years, investors representing $3 trillion of assets under management have been warning of the potential for “stranded assets” -- oil projects that turn unprofitable when a) demand drops because of more fuel-efficient technologies or b) demand drops from taxes imposed to prevent the blistering worst of climate change.

What we’re seeing today is not the environmental stranded-asset scenario. Demand for oil has actually been on the rise -- up four percent since the beginning of 2012, according to IEA data. Instead, the recent price bust is mostly the result of a new glut of oil supply. Massive discoveries in North Dakota and Texas have driven down prices, even amid tensions in the Middle East and Ukraine that in leaner oil days would have driven prices higher. Roughly 3 million more barrels a day are being produced now than in 2011.

Even though this price collapse is largely supply-driven, it’s still threatening to strand oil assets and may be giving investors a hint of stranded assets to come. Many countries that depend on oil revenue to balance their budgets are already operating in the red.

Saudi Arabia needs Brent oil prices to exceed $91 a barrel to pay its bills, according to IMF estimates. That’s interesting, because Saudi Arabia actually has the ability to drive the price higher but has so far declined to do so. The biggest OPEC producer, with almost $800 billion in cash reserves to lean on, is opting instead to maintain market share and to test the break-even points of U.S. shale oil.

It’s a tough test, and OPEC may not like the results. The break-even for American oil has been falling as fracking techniques are refined. The U.S. is producing unconventional oil with acceptable returns in the range of $70 a barrel for oil, less than most OPEC nations can sustain.

There’s little incentive for U.S. producers to slow down anytime soon. Even the drillers who do get squeezed will be loath to cut production. Investors tend to punish exploration and production companies that slow their pace.

If prices continue to fall, there will be losers outside the oil patch. The drive toward renewable energy technologies will be slowed. Median stock prices for solar energy companies have fallen almost 30 percent in a month, tracking the decline in oil prices. Sales of electric cars also move in step with the price of oil.

There will also be winners -- millions of them. For every $10 drop in the price of a barrel of oil, world economic output increases by almost half a percentage point. Prices at the gasoline pump have already dropped about 50 cents a gallon. That translates to about $500 a year in savings for the average gas-guzzling U.S. household.

And if the history of oil prices has taught us anything, it's that these low prices will continue -- until they don't.

More from Tom Randall:

Follow @tsrandall on Twitter for more break-even points.

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