The Edge

Tight oil’s second great growth phase about to begin?

1 minute read

Tight oil, subdued by low oil prices, is already showing signs of resurgence. More operators are hinting through this Q3 results season at redeploying rigs in the coming months, potentially kick starting what will be tight oil's second great growth phase. How big could it get? Which companies are set to drive the growth? And should Shell sell its Permian position into a hot tight oil M&A market?

OPEC's price assault on future non-OPEC production has been highly effective, killing off investment in new conventional projects. We estimate around 4 million b/d of production from pre-FID projects has been ' lost' by 2021 through deferrals. An oil price below US$50/bbl has done its job, and it'll be some time before the industry girds its loins for another wave of conventional investment given average pre-FID break evens of US$60-65/bbl.

The same cannot be said for US tight oil. Our latest, granular analysis of tight oil plays frames the potential.

We estimate that 7 million b/d of new tight volumes can be brought to the market over the next ten years with an average break even price of US$47/bbl.

Tight oil operators responded to low oil prices by focusing on play sweet spots, cutting costs by 30-50% through productivity gains and efficiencies. Lateral wells extending to just over 4,000 feet two years ago are now routinely drilled to over 7,000 feet. Operators in the SCOOP/STACK, the Mid-continent play with some of the lowest break evens of all, now pump 12 million lbs of sand (proppant) per well, three times that in 2014. Production per well is up 40%, and these techniques are about to be rolled out to 'second tier' plays.

We forecast US tight oil production will rise from an average 4 million b/d in calendar 2016 to over 8.5 million b/d in 2026, net of decline from producing wells. The Permian alone contributes one-third of the increase. Tight oil drives total US production from 12 million b/d this year to above 17 million b/d. Among other non-OPEC producers only Brazil and Canada grow much over this period, each by around 1 million b/d; the rest are flat or decline. As a growth opportunity in oil, tight oil is in a class of its own.

A comparatively small group of producers, mainly US independents, dominates the space. Thirty E&Ps account for 3.3 million b/d or 80% of current tight oil production. EOG is the biggest (0.4 million b/d) but only two others produce more than 0.2 million b/d. Non-US companies are conspicuous by their absence from the upper echelons of the league table in 2016.

The leading companies are set to tighten their grip. By 2025, four US-listed companies - EOG, COP, Anadarko and Chevron - will each produce more than 0.5 million b/d. By then, we expect two non-US operators to rank respectably in the middle league - BHP Billiton with 0.3 million b/d comes 9th in the list by 2025 and Shell 15th(0.2 million b/d).

Shell's Permian tight oil position has been touted as a readily do-able sale in a generally tricky global M&A market to help meet its US$30bn post-BG disposal programme. Recent transaction metrics suggest the assets might fetch US$10-15 bn. Our NPV, 10 valuation is much lower at US$5 bn (2% of Shell's total upstream portfolio), based on a gradual build up of investment and production reflecting Shell's current capital constraints. However, the Permian eventually becomes Shell's second biggest source of oil production later next decade after Brazil, an indication of the strategic importance of the Permian not captured in our valuation.

The market for tight oil assets is hot, and we suspect there is a long list of potential buyers who would leap at the chance to secure a material Permian position – either incumbents looking to bolster an existing position or new entrants. A buyer could inject capital to accelerate growth.

But selling would weaken the portfolio in our view. The Permian gives balance to Shell's future growth prospects in oil - between the low breakeven pre-salt Brazil projects that BG brought; and short-cycle, low breakeven tight oil where investment can be turned on or off in response to price. The combination differentiates Shell, and in the Permian it is the only non-US major with any real skin in the game. Skin others would give their right arm to have.