At the same time, in response to the drop in oil prices, well drilling and completion costs, we were told, are down anywhere between 20 and 50%. The combination of these factors has led to a sharp fall in the breakeven level oil price at which shale wells are economically viable to drill, as the following chart demonstrates, which shows an approximate $20 per barrel drop in breakeven levels over the past year. It also shows the remarkable flatness of the shale cost curve.
While some producers we met “scratched their heads” at people getting back to work at $60-$65 WTI prices (in part for fearing it may tip prices downward once more), clearly this is a level at which a majority of participants believe drilling can recommence. It was also the level cited at which some wells, which had been drilled but were left uncompleted could now be completed.
What does all of this mean in practice? In our eyes, it suggests two crucial implications. One is that oil prices are unlikely to rebound quickly to $80 or $90 a barrel; if large quantities of shale are economic at $60 then that should dampen the likelihood of a price snap back. However, there are a huge number of moving parts in such an equation – not least that any pick up in shale activity might also lead to a surge in costs if skill shortages emerge amongst pumping crews.
The second implication feels rather surer: that a shale industry that is still improving in terms of efficiency and productivity, and is thus moving more and more towards the middle of the cost curve will have a core place in the global energy complex for some time to come.
Returning to our UK focus, it is this implication which is most positive for a business like Weir. To be clear, a lot of what I heard was quite negative for Weir in the short term. While drilling (and subsequent “fracking”) activity may be just beginning to return, there can be no doubt that activity levels remain hugely down on this time last year (the rig count has more or less halved).
In addition, although the relatively consolidated pressure pumping equipment market has seen less pricing pressure than other elements of the supply chain, this market has still seen double digit price cuts.
However, much of this is within investors’ expectations already. We know that 2015 will be an annus horribilis for Weir, but if shale oil has a sustainable longer term future, paying circa twenty times depressed 2015 earnings does not feel unattractive.
It was precisely this conclusion that came across quite clearly in Texas; that despite the current turmoil, shale is “here to stay”. We might have reached that same conclusion reading reports in our office in London, but we reached it faster and more convincingly after a few days’ at the coal face (or perhaps I should say well-head).
This confirms, once again, the value of the hundreds of face-to-face company meetings we hold each year – even when we are doing them half way around the world.
