The crash in oil prices has left oil companies racing to slash budgets, in some cases by as much as 50% in 2015. With OPEC refusing to cut production even if oil crashes to $20 per barrel, finding ways to lower the break even production cost of shale oil production is more vital than ever. According to Jim Burkhard, the head of oil market research at the energy research firm IHS, there are two factors that could save the U.S. shale oil industry, and both of them come from the same source.
Understanding these two factors and how they might help the oil stocks in your portfolio survive a prolonged period of cheap oil might be the difference between making or losing a substantial amount of money.
Falling oil service rates
Oil services companies, such as Schlumberger (NYSE:SLB), Baker Hughes (NYSE:BHI), and Halliburton (NYSE:HAL) -- three giants in the industry -- have spent the last few years building up an enormous capacity for oil services, such as fracking and drilling new wells. According to Mr. Burkhard, declining demand for services due to falling oil prices should put significant downward pressure on the pricing for these services, as well as the price of industrial components used in the oil industry, such as specialized piping, frac sand, and steel casings.
That decline in oil service pricing is already coming to pass, as ExxonMobil's CEO Rex Tillerson pointed out at the company's Analyst Day presentation: "We're capturing cost savings and we expect further bottom-of-cycle efficiencies, particularly in rig rates. We expect lower prices for commodities like steel and other raw materials, and we expect reduced contractor fees."
While significant discounts would certainly be bad news for oil services companies, it would also likely prove a godsend to U.S. shale producers. That's because, according to IHS, the break even cost of production for 80% of shale oil is between $50 and $69 per barrel.
With West Texas Intermediate -- the American oil benchmark -- trading around $48 a barrel, producers need to see oil service costs decline substantially just to keep production steady, given how quickly shale oil well production usually declines within the first two years.
Investors need to remember that oil companies have been through this before and know how to respond to this kind of oil price volatility. Sticking with good companies through these downturns and avoiding panic selling quality stocks are two of the best things you can do to protect your portfolio from yourself.
Re-fracking: A cost saving opportunity
The second trend that is gaining momentum is re-fracking of old wells, of which there are approximately 50,000 candidates oil companies are currently considering. In the past re-fracking of wells was largely done at random earning the technique the moniker "pump and pray". However, Halliburton, Baker Hughes, and Schlumberger are among the industry leaders in re-fracking because their expertise in identifying which wells are the best candidates for this technique. This gives them a leg up over smaller rivals and should allow them to better protect their margins in the coming quarters as oil services rates decline.
Why could re-fracking help save oil drillers? Because of the immense cost savings it can offer. That's because the average cost of re-fracking an old well is about $2 million, or 75% less than the $8 million cost of a newly fracked well. Thus, re-fracking offers drillers a way to increase production at minimal cost and maximize the profits from existing wells.