The Next Chapter for American Oil

For almost two decades American shale was largely a disaster for shareholders but beneficial for Americans. It kept oil prices lower, provided jobs and gave the Whitehouse political leverage in energy security at home and energy influence abroad, especially when facing foreign policy challenges with the likes of Russia and Iran. In 2015, under the Obama administration, a 40-year-old ban on oil exports was lifted, planting the seeds for the U.S. to become an oil superpower. As of today, the U.S. accounts for roughly 20% of global crude oil production, putting it in first place ahead of rival producers Saudi Arabia and Russia, which generate roughly the same share of the global total, around 11% each.

However, U.S. production growth is slowing down and the tables are turning for investors: Wall Street is now profiting from U.S. shale, after years of poor (or negative) returns. This may sound counterintuitive. To understand why let us first look at the development of U.S. shale over the past two decades, condensed into three chapters below.

Not quite the Permian Basin, but defunct wells in California’s Kern River oilfield do look ominous

1. Chapter One: This ran from 2008 to 2015 as the still relatively new shale technology began to actually work, even though it was difficult and needed nearly nonstop operations. After several weeks of high production, a well’s output would fall once the oil had dried up, meaning that more wells needed to be drilled. Profits from one well had to be immediately reinvested in setting up another and so shale producers were spending their profits plus borrowing. Investors bet on the promise that the economics would improve and that outputs would grow to huge numbers. U.S. production climbed to unprecedented levels.
2. Chapter Two: In late 2014 OPEC, worried about their flagging dominance, took control of the wheel and flooded the market with their own oil to bring prices down and gobble up market share. Many shale companies, which needed high oil prices to justify their cash-intensive operations, went bust or had to liquidate. From this a new era was born: the surviving companies were leaner, although still succumbed to financial vulnerabilities when oil prices dipped below a breakeven price of around $60 USD/BBL as they needed to constantly reinvest profits into new wells to continue producing oil as prior ones dried up. As a result of low returns investors began looking elsewhere while climate activists pressured financial institutions to stay away from fossil fuels. While sandwiched between these two pressure points the icing on top arrived in 2020: the pandemic.
3. Chapter Three: Emerging out of this painful second chapter is our current era. Not characterised by large annual production increases but instead by dividends and share buybacks, together with elevated energy prices. Goldman Sachs estimates that the publicly listed U.S. shale producers reinvested the equivalent of 120% of their operating cash flow into new wells in 2012, which later plunged to 40% in 2022. Capital discipline became the buzzword and financials returns for energy stocks were finally great again in 2021/2022 after years of poor performance. Wall Street is partying, although this will likely contribute to higher oil prices, lower job growth in the oil sector and less political leverage for Washington D.C as medium- to long- term production at home dwindles.

If oil demand peaks in the coming years then begins to decline, the fall in U.S. oil production shouldn’t be so concerning as it will fall in tandem with consumption. However, if oil demand continues to climb into the 2030s or plateaus at relatively high levels, which many believe it will, then this is a more pivotal risk for the U.S. state of affairs, their allies, investors and consumers.

Shale has somewhat accelerated the energy transition: It is worth highlighting that shale also transformed the domestic natural gas market, reducing prices to a point that gas pushed coal out of the American power system, sharply reducing carbon emissions as natural gas is far cleaner. This has also helped grow Americans’ ability to liquify (into LNG) and export the gas, which doubles as political leverage today by supplying an LNG lifeline to Europe as they cut Russian energy imports and look elsewhere for much needed oil and gas supplies. Similarly, if local (petroleum) fuel prices rise as a result of lower domestic oil production then electric vehicles will become more competitive in consumers’ eyes, although the inverse may also occur.

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