Saudi Flexing Met With Crickets by U.S. Shale Frackers

Saudi Arabia’s rivals in the shale fields from North Dakota to Texas aren’t flinching as the Persian Gulf kingdom wages a price war to reclaim market share and chill competition.

The U.S. companies believe they have a lot more staying power than many of Saudi Arabia’s partners in the Organization of Petroleum Exporting Countries, or OPEC. Several producers plan on increasing production.

“Saudi Arabia is really taking a big gamble here,” Archie Dunham, chairman of shale producer Chesapeake Energy Corp., said during a telephone interview. “If they take the price down to $60 or $70 a barrel, you will see a slowdown in the U.S. But you’re not going to see it stop. The consequences for other OPEC countries are far more dire.”

The decline of global benchmark Brent crude, touching a four-year low yesterday, added to market jitters as Saudi Arabia prepares to meet with its 11 fellow cartel members on the U.S. Thanksgiving holiday Nov. 27. After cutting its price for crude sold to the Americans, the worry is Saudi Arabia will choose not to pare production to help balance supplies and boost prices.

That may work for Saudi Arabia, which has enough cash and other assets stashed away to withstand oil around $50 a barrel, said Dunham, also former chairman and chief executive officer of ConocoPhillips. But “the vast majority of the OPEC producers cannot make their budgets and keep their people happy with prices below $80 a barrel.”

Raising Production

Executives at several large U.S. shale producers, including Chesapeake and EOG Resources Inc., have vowed to maintain -- and even raise -- production as they reported earnings this week. They say their success in bringing down costs means they can make money even if prices slump further.

“It doesn’t scare us here at Whiting to compete at the current oil prices or even a little lower,” Whiting Petroleum Corp. Chairman and CEO James Volker said during a conference call with analysts last week. “It shows the quality of our inventory, our ability to grow and still add net asset value per share.”

Continental Resource Inc. and Pioneer Natural Resources Co. are among shale drillers that have indicated they have no plans to curtail drilling in response to the price collapse. Same for ConocoPhillips and Marathon Oil Corp., which said their opportunities in formations from Texas to North Dakota are among the most profitable options they have for investing.

New York oil futures lost almost one-third of their value in the past 4 1/2 months, dropping below $76 a barrel on Nov. 4 on concern about a potential supply glut.

Saudi’s Decision

The OPEC meeting later this month in Vienna will be the organization’s first since oil prices began their descent in June. Saudi Oil Minister Ali Al-Naimi is heading to fellow oil producers Venezuela and Mexico for meetings ahead of the official session.

State-controlled Saudi Arabian Oil Co.’s decision this week to cut the price it charges American refiners for crude was seen as a move to shore up its customer base in a market that accounts for more than 20 percent of global crude demand. Shale oil has been capturing more of the domestic refining market at Saudi Arabia’s expense as U.S. crude production jumped to the highest in three decades.

Lower Costs

Shale producers cite their success in reducing costs as proof that they can still be profitable at prices below $70. In Chesapeake’s two largest production areas -- Pennsylvania’s Marcellus Shale and the Eagle Ford formation in Texas -- well costs dropped 11 percent and 13 percent, respectively, during the first seven months of this year compared with 2013, the company said yesterday.

EOG can make money at $40 a barrel in the Eagle Ford, Chairman and CEO William Thomas said yesterday on a conference call with investors. The region produces about 1.6 million barrels a day, about the same as the nation of Qatar.

U.S. producers will come under more pressure to throttle back spending if crude prices continue to fall, and stay at $70 a barrel or less through 2015, Barclays Plc said in a report yesterday. Even with lower costs, companies that have relied on debt to fund drilling will face greater pressure as interest rates rise and access to funding is reduced.

About half of U.S. shale resources would be “challenged” next year if prices remain at $70, according to the Barclays analysts.

“The shale drillers can’t get into a price war,” said Ed Hirs, who lectures on energy economics at the University of Houston and runs a small oil and gas production company. “They’ll lose. The Saudis can enforce some discipline on the markets and run the shale guys out of business.”

Different Results

Some shale drillers are better-positioned to weather the price squeeze than others for one simple reason: all shale is not alike. Geologic variances, underground pressure differences and even the size of the microscopic pores within the stone can make or break a shale discovery.

For example, in the Bakken formation, producers with wells in an area known as the Nesson Anticline have lower production costs and reap more crude than those in other sections because the highly-pressurized nature of the oil trapped there makes the wells gushers. Conversely, weak underground pressure in the northernmost areas of the Bakken makes those wells more costly, less productive and more vulnerable when energy markets drop.

On average, Bakken and Permian shale oil producers need prices around $67 and $65, respectively, to make drilling worthwhile, according to ITG Investment Research. At the other end of the range are the Cana Woodford shale in Oklahoma, where producers need $100 to make a profit, and the Anadarko formation on the Texas-Oklahoma border, where $79 is the threshold.

Operator Expertise

The price shale producers need to turn a profit also varies depending on the expertise of the operator. EOG would get a 10 percent rate of return in Texas’s Eagle Ford field at an oil price of $40 a barrel, the company said. Royal Dutch Shell Plc, which sold many of its holdings in the same area, would only profit with a price above $112, according to an analysis by ITG.

Investors have shown little faith in shale explorers’ ability to maintain profits in a cheap-oil environment. In the last three months as prices fell, the 18 members of the Standard & Poors Oil & Gas Exploration Index lost an average 19 percent, shedding more than a $100 billion in market value.

Diamondback Energy Inc., a Midland, Texas-based oil producer in that state’s Permian Basin, lost 25 percent of its value since crude touched its $107.73-a-barrel peak for the year on June 20. Pioneer, another Permian-focused driller, fell 23 percent.

Bakken Producer

Whiting, which agreed in July to shell out $3.8 billion for shale explorer Kodiak Oil & Gas Corp., has tumbled 34 percent in that period. The Kodiak deal will make Whiting the biggest crude producer in North Dakota’s Bakken shale formation and boost Whiting’s output by 50 percent next year.

For the best operators, the downturn could prove to be a boon if cash-strapped companies are forced to sell assets, giving them the chance to reinforce their drilling portfolios.

Whiting’s Volker, 68, told analysts and investors during an Oct. 30 conference call that falling prices aren’t all bad for the industry.

“That particular downturn that we’re existing in here -- and I might say that yours truly has lived through six of these in my 40-year career -- and I can tell you that they all provide opportunities as well as pain.”

So far, there’s no evidence that shale drillers have been discouraged by the price plunge. U.S. crude production has risen for 11 straight weeks, topping 8.9 million barrels a day in the week ended Oct. 24, according to data compiled by Bloomberg.

“This is not a boom here in America,” Harold Hamm, the billionaire CEO of Continental Resources Inc said in an interview. “It’s a renaissance. It’s going to be here for 50 years. It’s not something that’s going to come and go.”

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