Prospect of shale wave looms over resurgent oil prices

While oil prices continue their claw back this month, there is concern in the industry that as the market rebounds, some producers in the U.S. will turn on the taps and flood the market with oil and once again stymie the recovery.

The North American benchmark for crude oil opened at over $60 US per barrel at the start of the year and has continued to hover comfortably above that mark through January.

While higher oil prices may not be welcomed by consumers, it's good news for a sector that has laboured under a massive supply glut which weighed mightily on the market until recently.

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But still looming over the recovery is United States shale oil, which played a key role in helping create the glut and was blamed for killing a short-lived rally early last year.

The concern is that the current resurgence will renew interest in more costly, second-tier shale projects that were shelved after prices tanked in 2014.

"Prices over US$60 per barrel will lead to more U.S. shale production," said a research note from TD Economics this month.

"With production on the rise in the U.S. — in addition to increases in Canada, Brazil and the North Sea — it is unlikely that prices will stay above that threshold on a sustained basis.

"What's more, with such a high level of speculation in the market, the risks for prices are heavily skewed to the downside."

American energy reports released in recent days suggest U.S. shale production is gaining momentum.

On Tuesday, the U.S. Energy Information Administration forecast said U.S. shale oil production will grow by 111,000 barrels a day to nearly 6.6 million in February.

That's good news for the U.S. economy, which continues to churn and consume energy, drawing down domestic stockpiles.

For some, the question now is whether the shale sector can continue at this pace. The rapid growth has stirred concerns that the industry is already peaking and that production forecasts are too optimistic.

With much of the activity focused in the prolific Permian Basin in Texas, the costs of labour and contracted services have recently risen sharply.

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"Most of this has been one-trick pony so far," commodities analyst Martin King said of the Permian Basin during a presentation at the Calgary Petroleum Club this week.

Drillable land prices have also soared and some shale financiers are calling on producers to focus on improving short-term returns rather than expanding drilling.

Even road congestion is an emerging issue.

"There are a lot of things going on… that suggest things could slow down to some extent," King said.

"We're not saying supply growth is going to stop. We're not saying it couldn't necessarily accelerate. It just takes higher prices, more rigs — get out the hammer and hit on the machine a little harder."

The world will be carefully monitoring U.S. production, particularly OPEC, which cut back its production last year and pledged to do the same in 2018 in a bid to wipe out the oil glut.

Ian Nieboer, director at industry research firm RS Energy Group in Calgary, said the question as to whether a big wave of shale production is coming remains unclear.

"The question that comes up a lot in the last couple weeks with the move up in crude is: Does that rig count need to go up or how does that change?" Nieboer said.

"It's a subject for a lot of internal debate and further thought but, at first pass, clearly there's more economic incentive to put more rigs in the field."

Nieboer said he's looking to see what happens in the Bakken Shale in North Dakota and the Eagle Ford Shale in south Texas.

Both are well below their peak activity but there's both infrastructure and human capacity to be able to deliver on higher activity levels in the two basins, he said.

"This stands in contrast with the Permian which is at all-time high levels of activity so even if there's high economic incentive to do more work, there may be some basin congestion and above-ground issues that constrain or perhaps throttle that activity a bit more," he said.

It will take sustained high prices, not price spikes, to see further activity drift back into the market, Nieboer said. And he'll be looking to see if shale producers show some of the restraint they have been talking about.

"Companies have tried to talk about being more responsible in their spending and that they would not react with more activity to higher prices," Nieboer said. 

"We'll see how long that lasts."