IEEJ：April 2015

○ｃ IEEJ 2015

Special Bulletin

A Japanese Perspective on the International Energy Landscape (211)

March 20, 2015

How Should We Interpret Shale Oil Production Resilience to Oil Price Plunge?
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, Japan

Crude oil prices have come under downward pressure again. The benchmark West Texas
Intermediate crude futures price had rallied above $50/barrel in February from a low of less than$45/barrel in January. In March, however, the price resumed a downward trend, sinking to a six-year
low below $43/barrel. The recent crude oil price trend has attracted global attention anew. I had anopportunity to talk with European experts on the matter during a March 17-20 European tour. I
would like to summarize interesting points of my talks with European experts.

These experts generally pointed out that market conditions including an easy
supply-demand balance are far from those for leading oil prices to start a full-blown rally. In
response to the sharp oil price fall until early this year, demand for inventories amid the emergenceof “contango” in the future price structure and China's special crude oil purchases to fill-in national
reserves were coupled with a spread of data indicating a substantial drop in U.S. oil drilling activities
to support oil prices. But these factors have fallen short of bringing about any sufficient
improvement in market conditions. Rather, as noted by European experts, oil market players havegrown concerned about an economic growth slowdown in China despite the economic growth target
set at 7% for 2015. The inventory expansion has pushed U.S. private sector inventories to a record
level beyond 450 million barrels, emphasizing an oversupply. The rapid inventory expansion has
implied the higher inventory level to be reaching closer at physical limit for storage, dragging down
any future inventory demand increase as a supporter for oil prices.

But they made another key point. It was that shale oil production's resilience to the oil
price plunge may be greater than expected. Shale oil production substantially increased when crude
oil prices remained above $100/barrel, and some industry sources indicated that the break-even costs
for shale oil production would be between $40/barrel and $80/barrel. Therefore, crude oil prices' slip
below $50/barrel had been expected to affect shale oil production growth. In fact, the International
Energy Agency revised its projection of this year's shale oil output growth from 1 million barrels per
day as estimated early this year to 750,000 bpd in March. But it is interesting that the IEA still1

IEEJ：April 2015

○ｃ IEEJ 2015

expects such magnitude of shale oil output growth even under the current market conditions.

As indicated by my talks with European experts, the key point for anticipating short-term
production under the current oil price environment would be that the short-term marginal production
cost rather than the break-even cost is important for oilfields in operation. For U.S. shale oil, themarginal production cost is possibly far lower than $40/barrel. Unless crude oil prices slip below themarginal production cost, continuing production is economically reasonable. Many European experts
also pointed out that shale oil producers might have made streamlining and cost-cutting efforts tosurvive the low-oil-price environment that is different from the past situation where crude oil prices
had exceeded $100/barrel. As a result, shale oil production costs might have declined. European
experts also noted that rig operations might have been suspended only at inefficient oilfields,
exerting little adverse impact on overall short-term shale oil production. Rather, rig operations now
continue only at more efficient oilfields, indicating that shale oil production still remains efficienteven amid the low-oil-price environment. This is interesting. Given this point, many European
experts view U.S. shale oil production as more resilient to low oil prices than expected earlier.

As oil prices have declined so much, however, shale oil development projects have begun
to be reviewed or delayed. But European experts explained that the abovementioned resilience
indicated that any early rally in oil prices would encourage these projects to be reviewed again
relatively earlier to expand supply. This means that a temporary freeze or delay on shale oil
production and development under low oil prices now serves to keep “inventories under the ground”
and would be lifted on an oil price rally to expand actual oil supply. European experts interestingly
noted that U.S. shale oil might have a high supply elasticity to oil price hikes as well as highresilience to low oil prices.

If shale oil’s supply elasticity is high, shale oil production may play agreater-than-expected role in holding down oil prices over a short to medium term. If shale oil
production is more resilient to low oil prices and more influential for holding down oil prices thanexpected by Saudi Arabia and other members of the Organization of the Petroleum ExportingCountries, they may have to review their strategy. Not only U.S. shale oil production, but also
demand trends, geopolitical risks and financial factors, will affect crude oil prices in the future.
Balancing all these factors appropriately will help stabilize oil prices. But we may have to closely
watch U.S. shale oil production as a key factor influencing the international oil market.

Contact: report@tky.ieej.or.jp
The back issues are available at the following URL
http://eneken.ieej.or.jp/en/special_bulletin.html
2