US Shale Oil Boom and Bust

Behind the US Shale Oil Boom and Bust

U.S. shale oil wells
Pump jacks and wells are seen in an oil field on the Monterey Shale formation where gas and oil extraction using hydraulic fracturing, or fracking, is on the verge of a boom on March 23, 2014 near McKittrick, California. Photo: David McNew/Getty Imagesoil

U.S. shale oil created a boom in domestic crude oil production. It rose from 5.7 million barrels/day in 2011 to 9.2 million barrels/day in 2014 and 9.4 million barrels/day in March 2015. It now comprises more than a third of the onshore production of crude oil in the lower 48 states. 

Thanks to shale oil production, reliance on foreign oil imports has plummeted. The U.S. Energy Information Agency projects U.S. reliance on foreign oil will fall to 34 percent by 2019.

That's down from 45 percent in 2011, and 60 percent in 2005. (Source: EIA, 2015 Forecast)

US Shale Boom and Bust

Two factors drove the U.S. shale oil boom. First, oil prices averaged above $90 a barrel for three years (2011- 2014). That's enough to allow shale exploration and production to be profitable.

Second, low-interest rates gave banks and private equity investors a strong incentive to lend to shale oil companies. The total amount of loans totaled nearly $250 billion in 2014. (Source: "Debt and Alive," The Economist, October 10, 2015.)

The production increase led to an oversupply that sent prices plummeting. Prices for West Texas Crude (WTI) fell from $106/barrel in June 2014 to $32.10 a barrel on January 7, 2016. That's nearly as low as the bottom during the Great Recession ($30.28 on December 23, 2008). For more, see Gas Prices in 2008.

Did U.S. shale production really create that much of an oversupply?

No. Price volatility was made worse by commodities traders. They trade oil futures contracts at an auction similar to the options market. That mentality can make them bid prices up during a shortage, and bid them down during a surplus. They did the same thing in 2008. Before sending prices down, they created an asset bubble, driving prices up to $145 a barrel earlier in 2008.

Another reason prices are so low is that shale oil producers kept drilling. They became better at cutting costs the more they drilled. Their bankers kept rolling over their debt as long as interest rates remained low. Many producers had already sold their oil on the futures market when prices were higher. That hedged their income. To maintain market share, OPEC also kept pumping oil. Normally, it would cut production as oil prices fell. (Source: "As Oil Keeps Falling, Nobody Is Blinking," WSJ, December 7, 2015.)

The boom and bust cycle is coming to an end. First, banks use oil reserves as collateral. As oil prices drop, so does the value of the collateral. As a result, many drillers are "upside-down." The same thing happened to many homeowners during the subprime mortgage crisis.

Second, the Fed is raising interest rates. That makes lenders less willing to roll over debt. That means many companies must pump enough oil to generate enough cash to make their monthly debt payments. They will do this no matter how low prices get, and even if they are no longer profitable. Smaller companies, such as Sandridge Energy Inc., Energy XXI, and Halcón Resources, used 40 percent of revenue last year to make monthly payments.

(Source: "Oil Plunge Sparks Bankruptcy Concerns," WSJ, January 11, 2016.)

Third, futures contracts are now priced so low that many frackers can no longer afford to keep drilling. As of October 2015, about half were sitting idle. Dozens have already filed for bankruptcy, and 55,000 workers have been laid off. (Source: "Frackers Who Drove Boom Struggle to Survive," WSJ, September 24, 2015). To find out where oil prices are headed, see Oil Price Forecast.

US Shale Oil Reserves

The Bakken Field in North Dakota and Montana is the largest producing shale oil reserve. The field has layers of dense, oil-bearing rock about two miles underground.

The field is roughly the size of West Virginia and produced 770,000 barrels of oil a day (as of December 2012). Although production started to take off in 2006, levels doubled in just the last two years. At this point, 95 percent of production is from horizontal wells. As a result, North Dakota extracts more oil than Alaska and is closing in on the two million barrels a day produced by Texas. In 20 years, its number of wells could increase from the current 8,000 to at least 40,000. Part of the reason for expansion is that each well runs dry after about two years. That's because the oil is trapped in pockets that don't hold as much oil as traditional wells. However, in total, the field could contain nearly 4 billion barrels of shale oil. (Source: EIA, Bakken formation oil and gas drilling activity mirrors development in the Barnett, November 2, 2011; CNBC, Bakken Emerges as Contender for US Oil Drilling Crown, March 23, 2013) 

The Eagle Ford field in Texas produced 750,000 barrels/day as of 2011, nearly all from horizontal wells. The U.S. Geological Survey estimates there are 853 million barrels in undiscovered reserves. Drillers are searching for both oil and natural gas. (Source: EIS, Trends in Eagle Ford drilling highlight the search for oil and natural gas liquids, November 2011)

The Utica field in Ohio has anywhere from 1.3 and 5.5 billion barrels of oil. Ohio is currently producing 5 million barrels of oil a year. So far, the oil reserve is still being explored. (Source: EIS, Oil and natural gas drilling in Ohio on the rise, September 2011) 

The largest U.S. reserve is the Monterey Shale formation near Bakersfield, California. It has four times the oil as the Bakken Field in North Dakota. It's 1,750 square mile area contains 15.4 billion barrels of oil - about 2/3 of the nation's total shale reserves. The California shale oil is much more difficult to extract than the Bakken, and environmental groups are much more opposed. That's because its geological formation requires more intensive fracking and deeper horizontal drilling. That's of concern in a state that lies on the San Andreas fault, and already gets more than its fair share of earthquakes. (Source: NYT, Vast Oil Reserve May Now Be Within Reach, February 4, 2013)

US Shale Oil Companies

The top five shale oil companies--EOG Resources, Anadarko Petroleum, Apache Corp., Chesapeake Energy, and Continental Resources--pumped 10% of total U.S. crude production in 2014. While smaller shale oil companies that took on debt may go bankrupt, these five will probably survive, if not prosper. (Source: Erin Ailworth and Benoit Faucon, "U.S. Producers Ready New Oil Wave," The Wall Street Journal, March 14-15, 2015.)