When will tight oil make money?

Tight oil profitability has been the focus of much debate since the oil price collapse of 2014. Its ability to scale down (and up) quickly and break even at low price points has made the Permian the star of the show for investors — but there are still plenty of sceptics.

We believe tight oil producers will begin generating significant free cash flow in 2020.

Tight oil specialists failed to generate positive cash flow in 28 of the 29 quarters since 2010. We've found that tight oil requires as much upfront investment as conventional projects, and like most early-life operations, comes with its own learning curve and infrastructure development – as well as being highly sensitive to the downturn in price. It will take a while to generate returns.

Our response to tight oil sceptics

Andy McConn, Principal Analyst, discusses why we shouldn't have expected tight oil to deliver profitability right out of the gate:

Permian perseverance

All eyes seem focused on the Permian, and with good reason: in our analysis, it accounts for 60% of tight oil growth through 2025. Tight oil sceptics may view Permian fever as a reprise of the roles the Bakken and Eagle Ford played three years ago, but in fact, we're watching a different mise-en-scène unfold.

Technological and production improvements have boosted our forecast, and the Permian is an outlier in its vast size and structurally lower cost. Its inventory of sub-US$50/bbl breakeven wells to be drilled is substantial.

Sentiment-driven growth

One cautionary note is Wall Street's enthusiasm for tight oil investment inadvertently hampering its journey to positive cash flow. Because of its marginal position, tight oil's greatest sensitivity is to changes in oil price. The delicate interdependence of price, productivity and available capital creates a three-legged stool on which profitability sits only when it is balanced.

Should investors pump too much capital into tight oil, driving producers to make good on it, the industry could face an over-supply that threatens to drive down oil price and take profits with it.

The road to returns

Tight oil's road may not be completely smooth — but it is the most attractive investment theme in the global industry because the potential resource is so huge, some of it low cost. We believe that by 2020 production will climb to nearly 7 million b/d from 4.2 million b/d today, based on our WTI assumption of US$63/bbl. And the five leading tight oil specialists will start to deliver significant positive free cash flow from the same year.

But there are many risks. And if tight oil doesn't deliver on bullish expectations, a lack of investment in conventional oil since 2014 means there would be a shortage of supply on the market. Prices will rise sharply.