Anybody who has been to a gas pump in the last several months can tell you that the energy industry is currently in the throes of change. Prices are falling to lows that they haven’t seen in almost a decade and the industry itself is being impacted in a large number of different ways. The changing face of economics and the marketplace has presented an entirely new set of challenges that businesses will have to adapt to in order to thrive well into the future.
Another significant change that will impact the oil and gas industries in 2015 and beyond has to do with current market fluctuations that will affect profitability. It’s no secret that oil prices started plummeting in 2014 and show no signs of slowing down. Bernstein Research, for example, estimates that a full 1/3 of all shale projects in the United States become unprofitable once prices fall below $80.
This is a case-by-case basis, however, and is not blanket fact. The Bakken formation in North Dakota, for example, will still be profitable so long as prices do not fall below $42 per barrel – according to the IEA. ScotiaBank’s own research indicates that prices have to stay between $60 to $80 per barrel for the Bakken formation to remain profitable.
A large part of the reason why oil prices are continuing to fall has to do with two other significant changes that are impacting the industry: namely, changes to the total amount of oil that the United States and Canada are producing, as well as changes to the demand for oil in areas of the world like Europe and Asia.
According to the International Energy Agency (also commonly referred to as the IEA), shale production in the United States is expected to shift dramatically in the coming years. In scenarios both where oil prices remain roughly where they are and where they continue to fall even farther, the IEA predicts that shale production will still continue to grow, just at a much slower rate than it has been in the last several years. To put that into perspective, production is still expected to increase an additional 950,000+ barrels per day throughout the entirety of 2015.
Another important factor to consider has to do with infrastructure with regards to existing investments. There are a large number of energy companies that have already paid a great deal of money purchasing land, obtaining necessary permits and performing other tasks necessary to drilling. Even if oil prices continue to fall, these companies can’t necessarily curb back on their production or they fear losing an even greater investment than initially feared. In these types of situations, the true “break even” price in production varies depending on the operator and their tolerance versus the amount of debt that they’ve taken on. Even still, it may be too early to tell in many cases how firm those tolerances really are.
The boom in increased oil production in the United States and Canada has created something of a tricky situation for the industry as a whole. After sinking a huge amount of money into infrastructure over the last several years, businesses now have to contend with falling prices that show no signs of slowing down. In order to adapt they will have to look for ways to embrace new technology and streamline production in order to stay profitable well into the future and to break through into a bold new era for the industry as a whole.
This article was originally published in Valuation Viewpoint, January 2015.