The American Oil Boom Won't Last Long at $65 Per Barrel

U.S. shale oil production Photograph by Gregory Bull/AP Photo

So maybe OPEC does still matter. After deciding to keep its production levels unchanged at 30 million barrels a day and triggering Friday’s nearly 10 percent selloff, the cartel proved it can still cause huge swings in oil prices‐even if it’s in the opposite direction that most of its members wanted to see.

Iran, Iraq, Libya, and Venezuela were all hoping for a cut of at least 1 million barrels to keep prices from going lower. Citibank analysts estimate that the world is producing about 700,000 barrels a day more than total demand requires. With international oil prices below $70 for the first time since 2010, most OPEC member countries will have trouble keeping their budget deficits in check. According to an estimate by Goldman Sachs last month, only Kuwait, the UAE, and Qatar are safe below $70.

OPEC’s idea is to try to knock out U.S. shale producers by driving prices lower than they can afford. That way Saudi Arabia, the cartel’s biggest exporter, can keep its market share in the U.S. But the damage to its fellow oil exporters could be severe. In Russia, for example, the ruble is plummeting. Iraq is already having trouble fighting ISIS, and lower oil prices won’t help. Libya is in chaos. Venezuela’s economy, already on life support, depends on oil for 95 percent of its export revenue. Iran’s oil minister on Friday told Bloomberg News that he has doubts the strategy will even work: “There’s no fact or figure to say that shale production will definitely decrease,” he said.

U.S. production probably will decrease, even if it takes a while. At $65 a barrel, it’s unlikely the U.S. can keep up its record-setting pace of expanding oil production. U.S. oil has jumped from about 5 million barrels a day in 2008 to more than 9 million. Even before OPEC’s decision, forecasters were calling for a slowdown. Last May, for instance, the Energy Information Agency forecast that total U.S. production would peak just shy of 10 million barrels per day before 2020.

U.S. crude production forecast to peak in 2019

The question is: How soon will prices start eating into that growth? It might actually take most of next year. Money is already invested in wells that are producing right now; it’s future wells that are at risk as oil companies slash investment for the next few years. “Don’t hold your breath for a production response, since there will be a six-month lag between a drop in rigs and a slowdown in production,” writes Manuj Nikhanj, head of energy research at Investment Technology Group.

That will have a major impact in the next few years, especially since U.S. shale accounts for about 20 percent of all crude oil investment in the world. For the next several months, though, the U.S. will likely keep flooding the market with crude, which should continue to make it cheaper. There’s already talk of prices hitting $40.

On average, the Bakken formation in North Dakota and Montana has a higher cost than some of the other big shale plays in Texas, such as the Eagle Ford and Permian. The Bakken’s biggest operator, Continental Resources, run by billionaire Harold Hamm, holds about 1.2 million acres of land in the region. That’s well above the next largest leaseholder, Exxon Mobil, which holds 845,000 acres, according to data from Bloomberg Intelligence.

Top leaseholders in the Bakken
Bloomberg Intelligence

The Bakken has been one of the primary engines of growth for the U.S. Since 2007, oil production there has risen from less than 200,000 barrels a day to more than 1 million. The boom happened so fast, pipeline companies didn’t have time to build enough lines to the fields. The result has been a bonanza for railroad companies, which have quickly filled the gap. For the past two years, most of the oil that has left North Dakota has done so on a train.

Bakken crude production

For Bloomberg Businessweek’s Year Ahead issue, Hamm boasted that Continental could operate at $50 a barrel. Now the world will probably get to find out if that’s true.