This past week ExxonMobil (XOM 0.02%) CEO Rex Tillerson told CNBC that his company could weather a downturn in oil prices all the way down to $40 per barrel. He’s not alone as EOG Resources (EOG 0.59%) also noted that many of its shale plays can still produce a positive economic return at that price. While that doesn’t mean either will produce robust returns if oil prices crash, it does point out the importance of having the very lowest cost production as it provides a lot of breathing room.
Focusing on costs
Exxon’s CEO noted that his company has tested its projects across a broad range of oil prices with some needing $120 oil to make money, while others can make due with $40 oil. Because of that he feels that his company can weather any downturn in oil prices to that point. That’s a good point of reference considering that oil prices only briefly dipped below that price during the financial crisis.
Brent Crude Oil Spot Price data by YCharts
With that history it would suggest that even if oil prices dipped below $40 per barrel, its stay there would be rather brief.
Still, given the precipitous fall in oil prices, his company, and others in the industry, aren’t going to take any chances that lower oil prices won't be the norm for a while. Instead, oil companies will focus on investing in projects that can deliver high margins at lower oil prices, so that there is a margin of error in case oil prices keep falling. To that end, Tillerson suggested that the fall in oil prices will force producers to become much more disciplined in spending and managing their cash. That discipline will likely lead to investments in higher cost plays being cut. However, it’s important to note that this doesn’t mean U.S. shale plays are toast.
Even shale can survive $40 oil
What might surprise some is that shale plays like the Eagle Ford Shale, Bakken, and even spots in the Permian Basin can still produce an economic return on new wells at $40 oil. EOG Resources actually has several drilling options at that price point, which are noted on the following slide.
Source: EOG Resources Investor Presentation.
What this chart suggests is that EOG Resources might choose to hold off on drilling new wells in places like the Wyoming DJ Basin Niobrara or the Midland Basin Wolfcamp for the time being. Instead, the company could chose to focus more of its attention, and capital, on the Eagle Ford, Bakken and Delaware Basin plays. As this next slide notes the company has ample drilling inventory across those plays to keep it busy while it waits for higher oil prices.
Source: EOG Resources Investor Presentation.
At the company’s current drilling rate it can keep going for the next 15 years. However, as oil prices continue to fall we would likely see the company’s rate slow down. That said, the company has an impressive inventory of future drilling locations in its lowest cost plays, which suggests that it can weather $40 oil for a long, long time. It also really helps that the company has a very strong balance sheet as its net debt-to-total cap ratio was just 20% as of the end of last quarter. So, without any looming debt issue, the company is in a very enviable position right now.
Investor takeaway
The downturn in the oil markets is a big reminder that low cost oil production is a huge competitive advantage. Exxon and EOG Resources can rest easy these days knowing that neither company is at risk of collapsing because oil prices would have to touch levels not seen since the depths of the financial crisis before any problems would arise. Moreover, the likelihood that oil prices would stay at that crisis level for an extended period of time is unlikely as it would knock out a lot of higher cost producers, which could quickly correct the current oversupply in the oil market.
