Oil May Surprise to the Upside with Shale Production Delays, Says Joe Dancy

Mon, May 20, 2019 - 10:22am

For the past two years the energy sector has been underperforming and recent news of potential supply pressures only adds fuel to the fire. Where’s oil headed? Financial Sense Newshour spoke with Joe Dancy, associate director at SMU Maguire Energy Institute, to get his take and find out how shale will affect the market.

Shale Acquisitions

The U.S. Energy Information Administration’s statistics for 2019 indicate record oil production, record natural gas production and record natural gas liquids production, Dancy noted. This paints a rosy picture, but things may not be what they seem.

While there’s been a spike in oil production with over 10 million barrels per day, it’s coming from unconventional sources.

The Permian Basin is one such source, and many big players are diving into the area. Estimates indicate we could see 18 to 20 billion barrels of oil come from these wells. It remains unclear if we’ll actually see that much production. Money from smaller players has already been poured into the Permian Basin, an area in western Texas and southeastern New Mexico, and they’ve yet to make money from their venture.

Considering cash flow models for the area, keep in mind that these models are very sensitive to oil price. There are profitable areas in the Permian Basin, but if oil goes to $50 or even $45, everybody is losing money. Dancy expects big players to tap these reserves due to the capital requirements to develop these wells and the economics of the region.

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“Going forward, I expect there will be more acquisition activity, and it might not be quite on the scale we've seen,” Dancy said. “There are quite a few private venture companies out there that raised some venture capital. Obviously, there’s an exit strategy. Part of that exit strategy is, you sell to a bigger player who you can develop for you. I expect to see more deals.”

Oil Price Pressures

At nearly $62 a barrel, some technicians suggest prices could drop to $55 a barrel. That estimate’s based on chart data and at that level many, if not all, shale producers would not be profitable.

Several supply disruptions are expected that could lead to higher prices. OPEC production cuts, Iranian sanctions and continued troubles in Venezuela all factor into potential higher prices.

The unknown factor is U.S. shale oil production. Thanks to unconventional shale sources, the U.S. has become the largest oil producer in the world. However, there are some misconceptions about where U.S. demand is headed.

While alternative energy sources are slowly gaining momentum, oil and fossil fuels will likely remain relevant for the foreseeable future. With the U.S. economy growing, we should see demand increases between one to two million more barrels per day.

The Permian Basin also struggles with pipeline capacity issues, and more capacity is coming online this summer, Dancy said.

Many shale companies will want to frack their wells, and Dancy sees two issues in the process. The first is sourcing and distributing water in the area, which proves to be difficult. The second issue stems from these companies laying off workers in the past year, with many workers leaving the area. The number of completion crews available to frack these wells may not be high enough to meet demand.

As these wells are completed, we’ll have to wait and see if their production numbers line up with expectations, Dancy noted. If production falls short, that’s a positive factor for oil prices.

Dany said, “the Permian Basin is really one of the few areas where there's an incremental positive out there. Everything else is incremental negative. … I'm relatively optimistic that I don't think we're going to go a lot below $60, unless there's a severe economic trade war or recession. I can't see anything skyrocketing either, but I can see a good $70 barrel oil for West Texas, $75 for Brent. It will make everything profitable.”

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