Shale sector to be cash flow positive by 2020

LONDON/HOUSTON/SINGAPORE/SYDNEY — The tight oil sector has struggled to generate positive cash flow since 2010 — many sceptics continue to question tight oil's value proposition. But there is light at the end of the tunnel. Wood Mackenzie's new report, 'When will tight oil make money', calculates that the five largest tight oil players could become cash flow positive by 2020.

The report's main findings include:

• In aggregate, under Wood Mackenzie's base case oil price forecast, the five largest tight-oil focused (Tight Oil Inc.) will achieve positive cash flow from 2020.
• Tight oil producers remain incentivised to drill aggressively to maximise value.
• Permian producers are best placed – they have access to a huge inventory of undrilled, cost-effective prospects that typically breakeven at below US$50/bbl.

But it is not all good news. Tight oil returns are highly sensitive to oil price, and in the event that oil prices remain flat or even fall (not our base case view), only the best operators, in the best plays can expect to make returns.

The report also identifies tight oil's two key advantages: the scale of the opportunity and capital investment flexibility.

Wood Mackenzie's analysis challenges some long-held misconceptions about the sector: that its overall payback period is quicker than traditional, conventional opportunities — it's not; and that it offers lower initial capital costs to achieve material production levels — it doesn't.

Andy McConn, principal analyst at Wood Mackenzie, said: "We are confident in tight-oil producers' ability to grow and generate free cash flow in a US$50-a-barrel oil-price environment."

He added: "We're only in the early stages of tight-oil development. Like any high-growth, capital-intensive investment, the first years are a poor indicator of future profitability. To date, high early-life costs have weighed on cash-flow metrics, but tight-oil producers have made great strides in honing technology and reducing costs. Collectively, that progress — as measured by well productivity and companies' cost structures — have improved immensely during the downturn, providing the necessary structural stability for sustained profitability."

The report also cautions that this vision of surging cash flow could prove a mirage if investors continue to focus on production rather than profitability and margins. Benjamin Shattuck, principal analyst at Wood Mackenzie, said: "By prioritising production growth over profitability and margins, investors and producers are at risk of killing their goose before it lays a golden egg."

He added: "Producers are being incentivised by investors to grow production and we think that has the potential to oversupply the oil market, with repercussions for oil price and profitability. Value could yet be destroyed rather than created."