IEEJ：March 2015

○ｃ IEEJ 2015

Special Bulletin

A Japanese Perspective on the International Energy Landscape (206)

February 12, 2015

U.S. Shale Oil Production under Plunging Oil Prices
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, JapanAs the substantial plunge in crude oil prices has brought about a new phase in theinternational energy situation, future oil price trends and various factors affecting these trends areattracting global attention. Undoubtedly, one of the key points in this respect is how plunging oilprices would affect the substantial expansion in U.S. oil output.

While there are various possibilities and uncertainties, oil production is still dominantly
expected to increase at least in 2015, even with the benchmark West Texas Intermediate crude pricehaving declined to as low as around $50/barrel. Given that oil output is expected to increase in
Bakken, Eagle Ford and other major shale oil production areas where productivity is higher (withhigher resistance to lower prices) and that shale oil producers have covered cash flow with hedging
at higher prices than at present, U.S. oil output is expected to avoid any sharp decline despite adecline of more than 20% from a peak in rig operations.

All representative oil production forecasters in their latest short-term outlooks havepredicted U.S. oil output to increase this year. The increase in U.S. oil production from 2014 isforecast at 630,000 barrels per day by the International Energy Agency, at 820,000 bpd by theOrganization of the Petroleum Exporting Countries and at 920,000 bpd by the U.S. Energy
Information Administration. They thus anticipate a U.S. production increase even under the lower
price environment, although this year's increase is estimated at far lower levels than last year's
expansion of well above 1 million bpd.

How will the medium-term outlook be beyond this year? While greater uncertainties exist
about the future course of crude oil prices and other matters over a medium term, the IEA on
February 10 released the Medium-Term Oil Market Report 2015 covering future years through 2020,
attracting global attention. This is because the IEA is the first one among the three to offer amedium- or long-term outlook on the oil market after the oil price plunge and the outlook is1

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important as a first reference material on the of impacts of low oil prices on medium-long term
perspectives.

Based on the shapes of recent crude oil futures price curves, the latest medium-term
outlook assumes the imported crude oil price to slowly rise from $55/barrel in 2015 to $62/barrel in2016 and to $73/barrel in 2020. The assumption represents sharp downward revisions from$102/barrel for 2015 and $87/barrel for 2020 as assumed in the previous IEA medium-term outlook
published last June. The IEA report describes U.S. shale oil production as basically being sensitive tooil prices, indicating that the projection of U.S. oil output including shale oil can be reasonably
expected to decline.

In fact, the IEA medium-term outlook lowers U.S. shale oil production estimates. Still, theoutlook forecasts U.S. shale oil output to continue an upward trend through 2020 with some pricerecovery taken into account. U.S. shale oil production is projected to increase from 3.6 million bpdin 2014 to 5.2 million bpd in 2020. Coupled with a natural gas liquid output increase, the shale oil
output growth will prompt total U.S. oil output to expand from 11.81 million bpd in 2014 to 13.96
million bpd in 2020.

Given that there are many small shale oil producers and developers, the IEA report notesthat their financial vulnerability and other problems could become downside risks for the future
shale oil output projections. At the same time, however, the report points out that the oil price plunge
could trigger cost reduction and streamlining efforts and technological development to improve theproductivity of shale oil development, becoming a driver of steady growth in shale oil production.
This is an interesting point. The IEA report also gives an analysis indicating that the break-even costfor 63% of U.S. oil output in 2020 could be $50/barrel or more. Therefore, shale oil production is
likely to decline or increase depending on future price changes.

U.S. oil output, including shale oil production featuring relatively lower initial investment
and the continuous drilling requirement, is expected to react to oil price changes. Oil prices' rise
above some levels could stimulate production expansion to increase supply and ease thesupply-demand balance, while their fall below some levels could lead oil output to stagnate totighten the supply-demand balance. Though falling short of working as a market maker to coordinate
supply and demand over a short term, shale oil may serve as a supply-demand balancer over a
medium to long term.

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As noted above, most global analyses have yet to come out about the oil price plunge's
medium to long-term impacts on supply and demand in the oil market. This year may see various
forecasters taking up the issue. In what direction will the international oil market will go? Whatshould major market players' roles be like in that process? While there are still a large number of
uncertain factors, a deep analysis is required to find out the future direction and market players'roles.

Contact: report@tky.ieej.or.jp
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