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Shale's Cautious Recovery

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Shale's Cautious Recovery

Oil prices near $50 a barrel is bringing cautious optimism to America's shale oil fields. The drilling companies that survived prices under $30 a barrel are discreetly increasing production, but are keeping a wary eye on global oil demand.

Is the oil market finally recovering for real, or is this another trap set by the market for US fracking companies?

Is It A Trap?

Memories of the "head fake" oil rally in the first half of 2015 are still fresh in the shale fields. Many companies rapidly increased production when prices hit $60 a barrel, only to be crushed when prices plunged back under $30.

Prices hit a 2016 low of $26.19 a barrel on February 11th. Since then, prices have almost doubled, but this time around, shale companies are far more reserved in their reactions.  Reuters interviewed Steve Pruett, CEO of a small drilling company in West Texas' Permian Basin. His company, Elevation Resources, has gone from hundreds of employees during the fracking boom to just 30 men and one rig. Pruett is putting off adding another rig until next year, giving him enough time to see if this rally will last. "We're going to ease back into the activity, not stomp on the accelerator," Pruett said. “We’ve all sobered up.

Survival of the Fittest

baker-hughes-june1-2016The land rig count for US oil rigs stood at 316 rigs on May 27. This is a drop of more than 80% from the high of 1,609 for the week of November 10, 2014. The shale drillers that are left are the ones who were the best at cutting costs, managing debt, and improving productivity.

These shale survivors have not only weathered the initial global oil glut, but also the 2015 "boom and bust." Those companies who borrowed heavily to ramp up production last spring found themselves insolvent when prices crashed below $40 a barrel again.

Timing the Jump

Now that prices are again hitting the $50 mark, the surviving oil companies have to decide if it's safe to increase production. A move too soon exposes them to another 2015-style trap. A move too late lets competitors get the lowest prices on equipment and support contracts, allowing them to be profitable if oil prices fall again.

Is The Global Glut Really Over?

Until recently, the drop in global oil production had been due to the fracking industry's fallen comrades in the shale fields. However, the last month has seen several incidents across the globe that has dropped total production by over 2 million barrels a day:

  • A monster wildfire in Alberta, Canada began on May 1, 2016, and was still burning out of control the first week of June. It caused the evacuation of tar sands operations, and shut down the pipeline that carried the crude to market, and will likely be the most devastating natural disaster in Canadian history. Estimated production lost: 1.4 million barrels a day.
  • A standoff between the exiled elected Congress of Libya and a new, UN-backed government in Tripoli resulted in the shutdown in early May of Libya's main oil terminal in the east of the country. An agreement was reached in late May to allow tankers to take on cargoes at the terminal. Estimated production lost: 100,000 barrels a day.
  • A new militant movement in Nigeria's oil-rich Niger Delta region has resulted in the continued bombings of pipelines and terminals, dropping Nigeria's production in half, to 1.1 million barrels a day. Estimated production lost: 1.1 million barrels a day.

Of these three major disruptions, the Libyan  bottleneck is clearing first. Canada will slowly get back to normal, depending on which way the massive wildfire moves. Nigeria is not likely to see a return to normal production in the foreseeable future. In fact, it will likely fall lower on further militant attacks.Is Shale Its Own Salvation or Demise?


With some disruptions of foreign oil production easing, and drops in US oil production starting to reverse, will the bounceback of shale drilling cause prices to drop below levels needed for them to survive? While it may shake out more of the fracking companies that are still hanging on, a fall in crude prices will be taken in stride by the leaders in the field.

Shale is probably the most nimble oil drilling sector. With hundreds of DUCs (Drilled, UnCompleted) horizontal wells in inventory, a new well can be brought online in less than two weeks. Whiting Oil, the largest player in the Bakken oil fields, says it has 100 DUCs of its own. The company is just waiting to see if prices can hold at $50 before flipping the switch and starting to pump.

The US shale industry may be the sector in global oil production that can most easily adapt to a "new reality" in oil. Petroleum is changing from a commodity where prices are dictated by suppliers, into one like most commodities, where prices are dictated by demand. Shale operators will operate as "swing producers," ramping up when demand pushes prices above $50-$55, and scaling back when prices drop, so that supply will match demand.

This also means that the US shale industry will likely dictate the ceiling on oil prices.

Friendly Fire

The lower output from the fracking fields is being countered by a growth in production from offshore oil rigs in the Gulf of Mexico. It takes anywhere from 2 to 4 years to put a deepsea offshore oil rig into production. This means that rigs started when oil was $100 a barrel are just now being completed. The oil company is going to pump, whether oil prices are high or low, in an attempt to recoup at least some of their expenses.

Remember how US onshore oil rigs have dropped to 316? Here's a June 2, 2016 map from the US Energy Information Administration showing active rigs in the Gulf of Mexico:

(US Energy Information Administration)

While shale oil has much of the same obstacles that is has had for the last two years, a pick up in global demand should make surviving a bit easier. This time, though, they are checking the depth of the pond before jumping in head-first.



The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product





About the Author

Everett Millman

Steven Cochran

Precious Metals Market Analyst
BS University of South Florida (2002)

A published writer, Steven's coverage of precious metals goes beyond the daily news to explain how ancillary factors affect the market.

Steven specializes in market analysis with an emphasis on stocks, corporate bonds, and government debt. He writes a monthly review of the precious metals markets for

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