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Shale-Oil Producers Ready to Raise Output

Bringing rigs back into service to test producers’ ability to react to rising crude prices

By GEORGI KANTCHEV and BILL SPINDLE
May 13, 2015 6:31 p.m. ET

News Link: http://www.wsj.com/articles/shale-oil-producers-ready-to-raise-production-1431556302

After slashing the number of drilling rigs for months, U.S. shale-oil companies say they are ready to bring rigs back into service, setting up the first big test of their ability to quickly react to rising crude prices.

Last week, EOG Resources Inc. said it would ramp up output if U.S. prices hold at recent levels, while Occidental Petroleum Corp.boosted planned production for the year. Other drillers said they would open the taps if U.S. benchmark West Texas Intermediate reaches $70 a barrel. WTI settled at $60.50 Wednesday, while global benchmark Brent settled at $66.81.

An increase in U.S. production, coupled with rising output by suppliers such as Russia and Brazil, could put a cap on the 40% rally in crude prices since March and even push them lower later in the year, some analysts say.

“U.S. supply could quickly rebound in response to the recent recovery in prices,” said Tom Pugh, a commodities economist at Capital Economics. “Based on the historical relationship with prices, the fall in the number of drilling rigs already looks overdone, and activity is likely to rebound over the next few months.”

One factor will be whether shale companies can quickly pump more oil.

Shale producers drill into oil-rich rock horizontally, then break it up with water and sand to extract the fuel.

The cost to get oil out of these wells varies widely. But producers can stagger outlays, for instance, by drilling but then waiting to pump the oil when market prices are optimal or extraction costs are lower.

For this reason, U.S. shale companies are increasingly being seen as so-called swing producers that as a group can boost production when prices are high and cut back when prices fall.

The implication for global oil markets is that in U.S. shale producers’ response, the world would have some counterbalance against big market swings in either direction. But that new flexibility hasn’t been fully tested in a major market downturn.

As prices fell last year, shale companies began furiously decommissioning rigs. Twenty-two consecutive weeks of aggressive cuts have left the industry with 930 fewer rigs, a 58% cut from their 1,609 peak in October, according toBaker Hughes, which tracks drilling activity.

In a report on Wednesday, the International Energy Agency, a Paris-based watchdog of the world’s biggest oil consumers, said it expects U.S. shale-oil output growth to slow by 80,000 barrels a day this month.

But meanwhile, other global producers, including the Organization of the Petroleum Exporting Countries, haven’t reined in production at all, and in many cases are pumping more. The IEA revised its forecast for non-OPEC production higher.

All that new supply could weigh on prices the rest of the year. Mr. Pugh of Capital Economics forecasts a price of $60 a barrel for Brent crude at the end of the year.

U.S. production grew by 1 million barrels a day each year since 2011 to surpass 9 million barrels a day last year. Although that increase accounts for only about 5% of global oil supply, it was enough to help trigger a price collapse in November. Amid the buildup in global supply, Saudi Arabia and fellow OPEC members kept the taps open, instead of throttling back production to prop up prices as they have done in the past.

During the price rout that followed that decision, some in OPEC and elsewhere said America’s new shale producers would be forced to retrench.

Shale producers’ rapid response helped put a floor under oil prices when WTI dipped below $44 a barrel in March from about $107 a barrel less than a year ago. Traders, investors and companies have been anticipating production declines in the coming months as a result of the pullback.

More recently, oil prices have climbed further from that floor. WTI is up about 40% since its March low. Amid that shift, market focus has also swung around sharply: Traders and investors are now watching to see how aggressively companies, including nimble U.S. shale players, may move to open up the spigots again.

Goldman Sachs said that if U.S. benchmark West Texas Intermediate oil prices settle above $60 a barrel, U.S. producers will eventually ramp up activity, spurred by improved returns, as costs have fallen due to efficiency gains. A slowdown in the rig-count decline suggests that producers are increasingly comfortable at current prices, Goldman says. Last week, the rig count fell by 11 to 668 rigs, the smallest drop since early April, after declining by 24 and 31 rigs in the previous two weeks and after shedding close to 100 rigs a week earlier this year.

Shale producers’ agility isn’t a given. OPEC has enjoyed its position as a swing producer because several key member governments, especially Saudi Arabia, have invested billions of dollars in developing spare capacity—wells they can quickly turn on and off in a crisis.

Shale producers, by contrast, are typically much smaller, independent actors, who react to prices—not to the whims of their governments. It is still unclear whether the flood of money that helped start and propel the shale boom can be turned on and off as quickly as the oil.

In past oil cycles, companies have also struggled to quickly turn on the taps after throttling back—amid logistical hurdles like securing equipment and enticing recently let-go workers back to the oil fields.

The IEA said Wednesday U.S. shale producers have already learned to shave costs. The recent price rebound “is giving [shale] producers a new lease on life,” the agency said. “Several large [shale] producers have been boasting of achieving large reductions in production costs in recent weeks.”

Last week, a parade of oil-company executives said they were ready to start to boost output if prices stabilize. EOG Resources, one of the largest U.S. shale oil producers, said that if U.S. crude prices stabilize around $65 a barrel, the company can restart rigs and expand production.

“If oil prices recover and stabilize at the $65 level, EOG is prepared to resume strong double-digit oil growth in 2016,” the company said in a statement.

Pioneer Natural Resources Co., another big shale player, said last week it hopes to increase drilling and add two new rigs per month from July if prices continue to rise. This would boost production growth next year, the company said.

Houston-based Occidental Petroleum raised its production growth outlook for this year by 20,000 barrels a day. It now expects to add between 60,000 barrels a day and 80,000 barrels a day to last year’s production average of 591,000 barrels a day. Continental ResourcesInc. Chief Executive Harold Hamm said that a $70 a barrel for U.S. oil is a price “that turns it on for us.”

And Jim Volker, chief executive of the largest Bakken Shale producerWhiting Petroleum Corp., also said last week that the company would ramp up production at around $70 a barrel for WTI.

Whether that is enough to check oil’s steady march higher remains to be seen.

Lower oil prices have boosted consumers and businesses. In cycles past, that has translated into heightened oil demand. And traditional oil producers, including many of the world’s biggest non-state-owned oil producers, are slashing spending and investment in ways that can’t be reversed nearly as easily as shale wells. Both will put upward pressure on prices. And U.S. shale production still accounts for a tiny share of global oil supply.

“Can shale cap the oil price? For a bit, yes,” said Pascal Menges,manager of the Lombard Odier Global Energy Fund, which has $76 million under management. But “North America’s unconventional producers do not have the ability to supply the entire world,” said Mr. Menges. “That’s 5 to 6 million barrels a day while the world consumes over 90 million and growing.”

Corrections & Amplifications

U.S. shale oil producers have slashed the number of drilling rigs over the past few months. An earlier version of this story incorrectly said that the companies have slashed production over that period. (May 14)

—Sarah Kent contributed to this article.

Write to Georgi Kantchev at [e-mail] and Bill Spindle at [e-mail]