Cost Savings May Be Here To Stay

Good News! Production Cost Savings May be here to stay.

            One hotly debated topic is whether or not the cost savings achieved by producers during the downturn are here to stay. If they are, drilling, particularly shale plays, is profitable even if oil prices are lower therefore reducing volatility and encouraging production because there is less fear of unprofitable wells should oil prices plunge again

            Many have felt that while Shale plays have achieved enormous cost efficiency as compared to its expensive beginnings, these cost efficiencies will quickly evaporate when drilling ramps back up. Logically, this makes sense as service companies, struggling under a decrease in business, have slashed prices in order to attract business. Therefore, the argument goes, once business grows back to more sustainable levels, service companies and others will raise prices again, thereby causing the break-even point per barrel to increase for newer wells. However, this does not account for structural cost changes achieved by the producers themselves.   Two recent stories give us some insight that sat least some of the cost savings achieved, which will allow fracking to occur profitably at much lower oil prices, are here to stay.

            In an article published by Reuters on June 20, 2016 (link: http://finance.yahoo.com/news/shell-puts-revamped-shale-arm-060456106.html), Shell announced and detailed their growth strategy and shift to unconventional plays. Shell told Reuters that unconventional energy is the center of their growth plan over the next few years. In explaining its new emphasis on unconventional shale plays, Shell provided us with the following insight:

1. The unconventional division of shell, by slashing costs and streamlining the decision making process has put the division costs close to leading rivals in terms of productivity and efficiency. These efficiencies were created by internal changes, such as cutting its technical check-list for drilling shale wells from 20,000 requirements to less an 200 and giving managers “end-to-end” control of production from exploration to well abandonment resulting in a 50% increase in efficiency over the past three years. Notably, production has increased 35% while capital spending is down 60%.
2. Shell plans to make small acquisitions near its current North American shale areas from struggling producers and hopes to launch an early production well this year in Argentina’s Vaca Muerta,
3. Shell makes a profit from shale oil in “sweet spots” in the Permian basin or Duvernay in Canada with crude prices of $40.00 a barrel.
4. Technology has increased so as to add 1-3% of oil as recoverable to the 7-9% of oil that is recoverable currently.
5. Shell engineers are using the experience to increase the efficiency of deepwater products.

            Not to be outdone, Chevron announced substantial cost reduction in Argentina’s Vaca Muerta shale, considered thee world’s second largest shale reserves (http://www.bloomberg.com/news/articles/2016-06-24/chevron-vaca-muerta-costs-drop-20-nearing-goals-moshiri-says).   According to Chevron, drilling costs at the Loma Campana field declined from $14 million per well to $11.2 million per well – a reduction of 20%.

            These announcements bode well for surface wellhead producers as a lower cost of completion allows producers to continue drilling despite lower oil prices. Moreover, seeing system wide cost reductions indicates that these lower costs will continue even once the market changes.