A January 11th post on the blog of RBN Energy focuses on drilling economics in the new cheap oil era. As author Sandy Fielden points out, the more than 50% decline in oil prices means energy companies are having to completely revamp their economic models: “In this new world where prices may not return close to pre-crash levels for a number of years, producers are scrambling to reconfigure drilling budgets and locations.”

Cheap oil

Decline in production will be gradual

Fielden points out that shale production is not going to grind to a halt as soon as prices reach a level that makes new drilling in existing fields uneconomic. He points to the dry natural gas field in the Haynesville basin in Louisiana as an example, and notes that production continued to increase for several years after gas prices crashed.

He also reiterates his January 1st prediction that, “Crude prices won’t recover or rebound anytime soon” and that “with no production cuts in the offing and a significant demand response years away, oversupply looks to be with us for a while”. In that same post he said that “U.S. crude oil production won’t decline anytime soon” and offered reasons why reductions in drilling in response to lower prices will take a while to work through the system.

Cheap oil

That said, the realities of much lower prices for crude, natural gas and natural gas liquids certainly make most new drilling uneconomic now, and all new drilling will be subjected to an in-depth financial analysis. Fielden also highlights that is not just a single price threshold that will lead to producer pullbacks in drilling (in projects that are already underway). Instead producers will examine each situation in terms of break-even drilling economics to figure out where to stop drilling and where to keep going.

The new math of the cheap oil era

After crunching the latest revenue numbers for U.S. producers given 50% lower prices, Fielden notes drilling budgets are going to have to be slashed. U.S. shale producers can expect to receive about $66 billion less cash flow revenue from existing crude production with prices at year end 2014 levels of $53 a barrel.

However, he notes that some of the lost revenue could be hedged: “That loss of expected revenue is the impact that producers have to manage in 2015, with the only relief coming to those companies that in months past had executed hedging strategies to protect themselves from a fall in oil prices.”

But hedging can only offer limited protection. Moreover, hedging strategies vary dramatically by company, and in most cases only provide protection for a year or two.