Source: Schlumberger 2015 annual report.
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Since the price of oil collapsed in the fall of 2014, virtually every shale producer has proudly boasted of huge "efficiency gains." The media has picked up on this trend, noting that as far as well economics go, "$40 is the new $70" for shale producers.
As far as Schlumberger CEO Paul Kibsgaard is concerned, those claims are a bunch of poppycock. At a recent energy conference, he told us why he thinks that.
Nothing has changed, shale is still a high cost source of oil
The more things change, the more they stay the same. That was essentially Kibsgaard's message at the recent Howard Weil energy conference.According to Kibsgaard, producers have responded to the current oil collapse just as they have responded to every prior collapse. The producers have dusted off the old playbook and reintroduced the "hold your breath and hope" strategy.
What this strategy involves is halting investments in exploration, aggressively curtailing development, and relentlessly squeezing pricing from the service industry.
Kibsgaard believes that almost all of the so-called "efficiency gains" being touted by shale producers relate to the squeezing of pricing from the service industry. This would involve big reductions in the cost of drilling and fracking shale wells.
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Source: Schlumberger Howard Weil presentation.
According to Kibsgaard none of these cost reductions are going to be permanent. As soon as oil heads higher and activity levels pick up, those service costs are going back up, as will the breakeven costs of drilling shale wells.
Kibsgaard surely has access to a lot of very good information as the head of the largest oilfield services firm in the world. We do have to note though that he does have some incentive to downplay shale given that his business is far more international in nature that that of Halliburtonor Baker Hughes.
Shale producers are going to have to become more efficient
After pointing out the temporary nature of the shale cost improvements, Kibsgaard then said that industry is going to have to do better. In his opinion, OPEC has changed the game, and oil prices aren't going to return to the $100-per-barrel level the industry enjoyed from 2012 to 2014.
That should be a major concern for shale producers, given that, asKibsgaard said, "the industry's technical and financial performance was already challenged with oil at $100 per barrel, as seen by fading cash flow and profitability."
Kibsgaard believes that going forward OPEC will be looking to keep oil at a level at which OPEC nations can generate sufficient profits but below the level where higher-cost shale, oil sands and deepwater producers can. In prior years OPEC (Saudi Arabia) was willing to produce at levels well below their maximum productive capacity. Since early 2015 the Saudis have shown they are willing to use most of that spare capacity to put pressure on prices, or as they would say "fight for market share".
The future for oil prices, according to Kibsgaard, is going to be "medium for longer." That means that if shale producers want to generate a sufficient return on investment, they're going to have to get better at what they do and create some permanent efficiency gains.
What this means for investors
For investors, there are a few of takeaways from the Schlumberger CEO's comments. The first would be not to buy into the idea that oil prices can't go higher, because drilling shale wells is now an incredibly profitable at $50 per barrel.
The second would be to realize that the pure-play shale producers aren't going to be tremendous cash-generating businesses without significantly higher oil prices. These service cost reductions aren't permanent (although they will be around for a while until activity levels pick up), and unless you're quite bullish on oil prices, pure-play shale producers are probably not companies you should have in your portfolio.
I would add a third observation as well. When researching these shale producers, and any other company as well for that matter, be aware that just because something is put into a fancy PowerPoint presentation doesn't make it true. Most of the shale producers have some very beautiful slides that show how their particular assets are very low cost and highly economic. My advice is to skip the corporate presentation and focus on the balance sheet and cash flow statements, which tell a far more truthful (and depressing) story.
The article Schlumberger's CEO Warns Investors That Shale Efficiency Gains Aren't Sustainable originally appeared on Fool.com.
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