Shale Cost Is Rising

Oil rig counts are rising but so are costs. Crude oil prices are modestly lower on weak Chinese PMI data and a rising rig count but the reality of the limitation of shale may start to become painfully obvious. While the number of active oil rigs increased for the 15th week in a row by 9 rigs, the cost of those wells increased by 7 percent between November and March according to the Bureau of Labor Statistics. That is the first significant increase in drilling costs in three years and that should continue to rise. With the rapid increase in drilling rigs, oil service and labor costs will go higher.

As OPEC continues to remove production from the global market, the increase in shale production, despite its best efforts, will not and cannot fill that void. Recent increases in efficiencies of shale rigs are being offset by the high cost of labor, rising oil service costs as well as the steep shale oil decline rate. Wood Mackenzie says that project and service cost will rise by 15 and 40 percent.

Big oil’s earnings have done well by cutting costs and moving production as they look to shore up profits at the expense of oil discoveries that have fallen to the lowest level in history. Big oil is back as Chevron and Exxon beat expectations but those profits came at the expense of future oil production. Chevron made $2.3 billion in the first quarter of this year, compared to a loss of $725 million in the same period in 2016. Its cash flow more than tripled to $3.9 billion. Exxon’s profits more than doubled to $4 billion in the first quarter, year-on-year. Big oil has now embraced cheap shale for quick profit turnaround at the expense of long term sustainable projects that are needed to meet the growing demand curve that we will be seeing.

U.S. production is up 327,000 barrels a day from last year and that is a small part of the Organization of Petroleum Exporting Countries (OPEC) 1.2 million barrels per day cut and does not even cover the 558,000 barrels per day non-OPEC cut. On top of that, as drilling costs rise, the break even on shale projects may slow the amount of shale projects and may make some banks think twice about extending money to drillers that are pumping more oil but losing money on every barrel.