The Daily Reckoning UK

Stubborn Shale Oil Producers Just Won’t Die

Sean Keyes

by

Posted 11th August 2016

The Saudis don’t give a stuff about low oil prices.

When Saudi Arabia decided to open the taps in November 2014, it kicked off the oil price rout. That decision led to nearly two years of carnage in the oil industry.

The drop in prices was meant to give control of the oil industry back to low-cost producers like Saudi Arabia and the rest of OPEC. US shale oil producers had been muscling in on OPEC’s turf.

And in case you were wondering, Saudi Arabia doesn’t appear to regret its decision. Because yesterday, it announced that it had pumped a record 10.67 million barrels per day in July.

The Saudis probably hadn’t planned on needing to pump quite so much oil for quite so long. But the shale producers have proven difficult to kill off.

The best laid plans

It costs more to pump “tight oil” from shale formations in the US than it costs to pump in Saudi Arabia, where it more or less oozes out of the ground. And shale oil producers tend to be small companies with limited financial resources. The Saudis planned to ruin them by “holding their head underwater” for a while.

After falling for three months straight, oil price seemed to hit a floor at $46 per barrel in January of 2015. The shale oil drillers – who were supposed to have been bankrupted by the falling oil price – piled back into the market at that point. They invested in new rigs and started pumping again.

For a few months, it looked like that decision was a good one. The oil price started to recover. It hit $60 per barrel in May of that year.

The same pattern was repeated over the following year: at first, the price collapsed to below $30 per barrel (January 2016); it hit a floor; and investors started pouring money back into the market, in order to expand capacity and open new rigs.

Capital is pouring into the oil and gas market at an extraordinary rate. Oil explorers have raised more cash from the stock market so far in 2016 than they raised in the entirety of 2013, when the oil price was at $100 per barrel.

How is this possible? Well, not just any oil explorer has been able to raise capital. Most of the money has been raised by producers such as Diamondback Energy (FANG:US) which are sitting on low-cost resources. So investors are happy to finance cheap oil drillers – particularly in the Permian basin, a slab of West Texas where oil can be extracted cheaply.
The Saudis must be raging. Shale oil was supposed to be dead by now!

Here’s the thing though. Most shale oil businesses are losing money, and building up debt. According to Arthur Berman, it would take the biggest tight oil rig companies an average of 10 years to pay off their debts – and that’s if all cash was used exclusively for the purpose of paying it off.

At some point, investors will lose faith in loss-making shale oil companies. Then, finally, the Saudis will have their wish.

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