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When oil prices were rising in the 2000s, many US companies found it profitable to go after hard-to-extract shale oil in places like North Dakota and Texas. This led to a massive "tight oil" boom, with US crude production rising 3.6 million barrels per day since 2008:
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Those high prices also spurred companies to mine the oil sands of Alberta — leading to a similar boom up in Canada.
But in 2014, oil prices have been crashing, with the price for West Texas Intermediate crude falling from $100 per barrel in July to below $70 in early December. That's partly because there's so much new oil coming out of the US and Canada, and partly because demand in Europe and Asia is weakening.
So now everyone's asking: If high prices helped create the oil boom in the US and Canada, will falling prices throttle it?
This turns out to be a surprisingly tricky question. Yes, most everyone agrees that falling prices will constrain US and Canadian oil production to some extent. The International Energy Agency (IEA) has forecast that US shale production will grow more slowly if current prices persist (though the agency still expects output to rise another 955,000 barrels per day in 2015). But estimates of the exact impact can vary widely. Saudi Arabia is predicting — and hoping — that the US boom will largely fizzle out at these prices. Other onlookers think drillers will remain surprisingly resilient.
Why the disagreement? Analysts often focus on a metric called the "breakeven price" for oil drilling projects. This is the oil price needed for these projects to be profitable and offer a healthy return on investment. Here, for instance, is ScotiaBank's estimates of the breakeven price for various US shale and Canadian oil sands projects:
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(ScotiaBank)
In theory, if the price of oil falls below the breakeven point for a project, drilling should get scaled back. The tight-oil projects in places like North Dakota and Texas are thought to be especially sensitive to price — since these wells decline faster than conventional wells, there is a continuous need for drilling rigs and financing.
But in practice, it can sometimes be difficult to predict the precise impact of lower prices.
Why the breakeven price can be hard to pinpoint
One complication here is that different analysts don't always agree on the breakeven price. The IEA, for instance, estimates that just 4 percent of US shale-oil projects become unprofitable if the price of West Texas Intermediate crude slides below $80 per barrel.
By contrast, Bernstein Research estimates that one-third of US shale projects are unprofitable at prices below $80. "We disagree with other estimates, including those cited by the IEA, which suggest the vast majority of shale oil production is robust at such prices," wrote Bernstein Research analysts in a note on October 24.
There are similar disagreements about individual regions. The IEA has argued that most of the oil production in North Dakota's vast Bakken formation remains profitable at or below $42 per barrel. But other analysts, including those ScotiaBank, have pegged the breakeven price for North Dakota's Bakken at between $60 to $80 per barrel. (See this Reuters' round-up from October for a list of different estimates.)
One reason for the wide range is that it's difficult to generalize about even an single region like the Bakken, where more than 100 companies are operating. Each of these operators can have wildly differing costs. They're using different methods to drill with varying levels of success. Some companies are operating in marginal geological formations. Some firms have hedged against falling prices. Others have taken on a lot of debt. This means different operators have different tolerances for lower prices.
There are other factors to consider, too. Many companies have already sunk lots of money into acquiring land and permits and may decide to continue drilling anyway, even if prices drop. That's why analysts often look at "mid-cycle" breakeven prices. It's also why falling oil prices are more likely to affect new investments than existing ones. (Reuters recently reported that permits for new wells in the United States dropped 40 percent in November.)
On top of that, firms can try to cut costs in response to falling prices. In recent years, shale operators like Continental Resources have reaped big efficiency gains from new techniques like multi-well pad drilling — drilling multiple horizontal wells from a single spot. If technologies like these keep improving, costs may go down and shale operators may be able to weather even lower prices.
Right now, a lot of investment banks and business reporters are doing their best to calculate how this all shakes out — and there are lots and lots of estimates for breakeven prices out there. If oil prices stay at their current level, we're likely to find out who's right.
Further reading: Oil prices keep plummeting as OPEC starts a price war with the US
