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GCA Article: Will US Shale Lose Out to Deepwater Projects in oil’s 2015 Pain Game?

Short-term investment models for shale make it more vulnerable to project cuts

GafffnetClineAssocWith oil prices plummeting to a five year low, and project cut backs likely in 2015, short-term funding for US shale may lose out to the country's higher cost deep water developments, the latest article by leading petroleum industry advisor Gaffney, Cline and Associates (GCA) suggests.

The current low price of oil has been blamed on reduced demand and a global oversupply. Much of that oversupply is due to the huge increase in oil production from the US unconventional or shale industry.

New analysis from GCA indicates that where companies have the flexibility to choose, shale activity will most logically suffer first as a result of the price crash, leaving activity in other areas such as the Gulf of Mexico relatively more protected. However actual cuts will be influenced by a large number of individual company factors, and the squeeze on cash flow will undoubtedly cause cuts to be felt everywhere.

"Whilst high cost environments such as the deep water Gulf of Mexico would appear to be vulnerable, and undeniably cuts should be expected there, economic rationality suggests that the brunt of cuts should be directed at onshore unconventional investments. However, in the short term there is not always the operational flexibility to make decisions based solely on fundamentals," says the article's author Bob George, Executive Director and Senior Strategic Advisor at GCA.

Another key difference for deep "water projects is their longer-term investment lifecycle. In the Gulf of Mexico (GoM) for example, where a company's investment in a typical project may be US$1 billion or more, much or all of the investment will be committed and spent around five years before any returns are seen. The critical point for such projects is not the price of oil now, but its anticipated price in the future and where deferral in the short term may result in missed gains later.

"From a decision-making perspective, this means the risk lies in the expected price of oil in 2020. As a result, projects currently underway are less likely to be stopped. This is in contrast to onshore unconventional shale investment where decisions are often much more short term," says George.

"Shale drilling can be cut back or ramped up in fairly short order to accommodate the market conditions, resulting in more rapid response to fluctuating oil price."

At the end of October 2014 GCA posted an article* looking at the potential impact of US$80 per barrel on activity in unconventional shale oil plays in the United States. The article indicated that, using the "sweet spot" volatile oil window of the Eagle Ford as an example, activity was still profitable at that price although more fringe areas (and other basins with pricing disadvantages) might be more challenged. However, even the sweet spots in the Eagle Ford oil window started to look challenged at US$70 per barrel.

Co-authors Cecilia Jing Cui and Neil Abdalla point out that strong offshore GoM projects can still be viable down to US$60 per barrel. Economic rationality would suggest that where the opportunity exists, onshore shale spending would be a more appropriate short-term target for capital deferral because operating flexibility allows any adjustments made there to be reversed in equally quick order.

Bob George states, "Although pain is likely for areas like the offshore Gulf of Mexico in 2015, it should be much better placed to weather the storm of depressed oil prices in the short term than the US onshore unconventionals industry."

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