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Are Shale Drillers Starting to Scrape the Bottom of the Barrel?

By Matthew DiLallo - Oct 8, 2017 at 11:31AM

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While shale drilling has proved to be resilient during the downturn because of efficiency gains and innovation, several signs suggest that the industry might be reaching its limit.

Oil companies in the U.S. have staged a remarkable comeback this year. Production, for example, which declined by nearly 1 million barrels per day at the low point last year, has roared back this year and is right back up near the 2015 peak. At the current trajectory, the country is on pace to produce an average of 9.8 million barrels per day in 2018, which would surpass the previous record of 9.6 million barrels per day set in 1970.

The driver of that rapid rebound in output -- other than the stabilization of oil prices around $50 a barrel -- was the ability of shale drillers to capture efficiency gains and push through technological innovation. However, there are several signs within the industry that it might not be able to go much further on either front, which suggests that the weight that has been holding back crude prices might soon lift.  

A land rig drilling at sunset.

Image source: Getty Images.

Losing the Midas touch

Last quarter, shale darling Pioneer Natural Resources (PXD 0.39%) stunned investors by unveiling a downward revision to its production growth guidance. The company, which had previously done nothing but outperform expectations, said it fell behind when drilling some wells as a result of "unexpected changes in pressure" in the red-hot Spraberry/Wolfcamp oil field in Texas. As a result, Pioneer Natural Resources had to change its well design, which solved the issue. However, that fix would tack an additional $300,000 to $400,000 to each well and increase its drilling time by five days, which reversed some of the prior efficiency gains that had been fueling its remarkable success. While the company said it was looking for ways to chip away at the added expenses and time, it will cut into drilling returns in the near term. It would also mean Pioneer's production comes it at the bottom end of its guidance range.

Meanwhile, several other shale drillers announced failed experiments as they tried to find the most productive way to unlock the oil and gas trapped in shale, which caused them to change their plans. QEP Resources (QEP), for example, recently stated that it "experienced higher than anticipated production decline from a group of pilot wells that were completed in deeper benches of the Three Forks Formation in the Williston Basin, and, as a result, we have modified our development plans going forward." On top of that, QEP said it "experienced some delays in our Permian Basin well completions as a result of the continuing evolution of our tank-style development methodology." Likewise, Sanchez Energy (NYSE: SN) noted that several wells that it completed within a trial program underperformed its expectation. As a result, Sanchez said it "returned to our standard well completion design." While both companies saw these delays as temporary hiccups, it suggests that shale drillers might be reaching the end of their ability to increase output through innovation.

Oil workers on a rig.

Image source: Getty Images.

Equipment and labor shortages are holding back growth

In addition to the growing number of technical issues, the rapid ramp-up in drilling activities this year seemed to hit the ceiling last quarter, which, according to reservoir optimization specialist Core Labs (CLB 0.10%), was the result of a transitory shortage in labor and well-completion equipment. Core expects these issues to persist through the end of the year and to cause the country's inventory of drilled uncompleted wells to increase, because companies haven't been able to keep pace with drilling. 

Oil-field service giant Halliburton (HAL 0.22%), likewise, noted that "current customer demand has outpaced the supply of completions equipment." However, while that's bad news for producers, Halliburton saw it as being a positive for its bottom line, because it "should create a runway for a strong utilization through the second half of the year." In a sense, Halliburton and its oil-field service peers are taking advantage of the opportunity to claw back some of the pricing concessions they gave customers during the downturn by purposefully holding back on adding more equipment until utilization and margins are at a more normalized level. Shale drilling costs are thus more likely to increase than decrease in the near term.

Shale's weight on the oil market might be lifting

One of the pressures holding down the price of oil over the past year has been the rapid improvement in shale drilling from efficiency gains and innovation. But the pace of change seems to be slowing, given the rise in technical issues the industry has encountered this year. Add to that the likelihood of higher costs as service providers try to rebuild their profitability, and it's looking less likely that shale can keep growing at a breakneck pace. Oil prices could therefore rise much faster than most anticipate, which could be a boon for investors in top-tier oil stocks.

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Stocks Mentioned

Halliburton Company Stock Quote
Halliburton Company
$31.43 (0.22%) $0.07
Core Laboratories N.V. Stock Quote
Core Laboratories N.V.
$19.83 (0.10%) $0.02
Pioneer Natural Resources Company Stock Quote
Pioneer Natural Resources Company
$223.94 (0.39%) $0.86
QEP Resources, Inc. Stock Quote
QEP Resources, Inc.

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