With OPEC Production Deal Threatening to Leak Oil, Will Shale Producers Capitalize?

OPEC countries announce record high production, but the potential for a deal breaker remains, and that's making oil investors skittish.

By Brian O'Connell


With the OPEC decision to curb oil production already at risk, some oil experts say shale oil producers could be a big beneficiary.

Here's some background.

Last week, OPEC announced that participating countries would curb oil production of 1.2 million barrels per day. Additionally, major oil producing countries outside of OPEC said they would cut production by 600,000 barrels per day, all in a bid to boost demand and lift prices.

But already global oil investors are nervous about the proposed deal, as Russia just announced its highest oil-producing month in 30 years in November, at 11.2 million barrels per day. Meanwhile, global demand for oil only stands at 95 million barrels per day.

Other factors in play are contributing to oil investors jitters this week. As OPEC has met to clinch the deal this week, industry observers aren't sure who's on board with the production cuts and who's not, and whether the deal has staying power. Also, U.S. oil production is rising so fast that it might offset any cuts by OPEC and other countries.

That has Globex crude oil futures sliding, with January 2017 contracts nearing $50, at 50.86 low on Friday Morning. February, March, April, and May contracts are pricier, though, at $52.60, $53.45 and $54.05, respectively. January oil futures, in particular, are seeing high-volume trading in Friday mid-morning trading, with 335,299 contracts changing hands. NYMEX crude oil is trading at $51.40 per barrel.

Even with all of that uncertainty, oil experts expect the OPEC deal to go through in some form, and that shale oil company shares should soar as a result, with oil prices eventually rising again.

According to a new report from Rystad Energy, the non-OPEC shale market can expect a big jump in investment thanks to the OPEC deal, with $15 billion in additional spending in 2017. In particular, non-OPEC shale well service provider should prosper, Rystad reports, with $10 billion in extra spending next year.

"2016 has been an even tougher year than the previous for most service companies, and revenue reductions range from 30% to 50% for onshore North American service companies. OPEC cuts will rescue a lot of these businesses," says Audun Martinsen, vice president of oilfield service analysis at Rystad Energy.

Other industry observers say shale oil and gas companies have been smart about cutting costs in recent years, and have boosted operating efficiencies. That leaves the shale sector primed to capitalize on lower global oil production.

"Since 2014, shale producers have significantly been improving efficiencies and cutting costs in order to continue drilling in suppressed pricing environments," says Avi Mirman, CEO at Lilis Energy. "The move by OPEC to cut production levels and the subsequent jump in oil prices have shale companies more confident in their ability to drill and produce above break-even levels."

"This is taking form as oil companies are increasingly moving capital expenditure and investment dollars back into shale plays, with the Permian Basin being the leader," Mirman adds.

Energy experts agree with that sentiment, although questions remain on exactly how much shale companies will benefit from the OPEC production cuts.

"OPEC's move to cut production clearly surprised the market, as evidenced by the uptick in crude prices over the last week," says Josh Sherman, a partner at Opportune LLP. "Although some questions remain about OPEC's ability to deliver on their commitment, I believe the shale industry as a whole will clearly benefit."

The extent of such a benefit is relative to the basin and balance sheet of the companies in question, Sherman adds. "At $55 per barrel, we're likely still $5 to $10 per-barrel away from breakeven pricing, for basins other than the Permian and STACK, when you consider leverage and a company's return on investment on its total asset base - not just the next dollar put into the ground," he says.

"Core-of-the-core" players with liquidity in those basins look really strong right now, Sherman adds. "Recently formed private equity-backed companies in the Delaware and SCOOP/STACK have, and will continue to be, a home run," he adds. "Great operators with solid credit metrics and core acreage in the Bakken and Marcellus are worth a look, particularly those who have opportunistically acquired such acreage in the pricing downturn."

Not everyone is on board with a shale price spike, at least in the next month or so. "In the short-term, shale producers will have minimal gains from the OPEC production agreement," says Albert Goldson, executive director of Indo-Brazilian Associates LLC, a New York City-based boutique global advisory firm.

Goldson says that, within the energy industry, larger shale producers have adjusted well to $50-per-barrel prices by cleverly reducing costs, however many smaller shale producers are unable to do so, and are in financial distress requiring a considerably higher price per barrel to regain profitability.

"Despite a unified public face, the dirty secret is that market share for each OPEC and non-OPEC member is paramount, and for this reason, their production agreement will unlikely hold which will, in turn, keep oil prices around $50-per-barrel," he says.

"Because of continued tepid world demand, a glut of oil inventory and OPEC's history of weak collaboration and weaker compliance on agreements - particularly with most OPEC members in economic distress - only a long-term investment in shale producers would be beneficial," Goldson adds. Click below to read the full article.

want more industry insights? subscribe below