There are two big questions hanging over the oil price in 2017. The first is whether the supply truce between Opec and non-Opec producers at the end of 2016 will hold. The second is how fast US shale producers will gobble up market share now that Brent crude once again costs $55 (£45) a barrel. Between 2011 and 2015 tight oil production increased from 1m to 4.5m barrels a day, but that period of growth has essentially been put on hold for the past two years by Opec-orchestrated oversupply. With prices now stabilising, this flexible yet cash-intensive form of production is once again starting to increase. You need only look at the Baker Hughes rig count, which, since hitting a nadir in May 2016, has seen the number of producing oil wells in the main basins rise every week. By Christmas, the count was 66 per cent off the bottom.
Few global energy investors have failed to notice that tight oil - the once-trapped sandstone oil now accessible through horizontal well drilling and hydraulic fracturing - is a highly leveraged bet. Not only did tight oil producers take on considerable debt in the boom years in order to fund new wells, but the industry's relatively high per-barrel cost means that valuations can quickly upgrade with small movements in the oil price. Of course, the opposite is also a permanent threat, and may prove the case if the Opec agreement arrives stillborn. But providing Saudi Arabia, Russia et al hold their nerve and reduce production in the coming months, they will be cheered by well owners in Texas and North Dakota.
From an investor's perspective then, US shale certainly looks on the cusp of growth at the beginning of 2017. According to analysis by Nordic bank SEB, tight oil producers should add 30 rigs a month in the first half of the year, before plateauing in July.
Room for doubt
Even with a lot of momentum behind it, there are reasons to doubt the longevity and force of the tight oil renaissance. First off, tight oil production volumes held up in the downturn partly because many operators focused on their best wells. The once unbounded improvements in production may soon be slowing; a study of the Bakken shale in North Dakota by Shell's former principal geoscientist, Jilles van den Beukel, estimates that the productivity and efficiency of tight oil drilling has plateaued. US Shale, Mr van den Beukel argues, has been a technological - rather than a reserves-based - revolution, and one that can't be repeated. Indeed, Rystad Energy estimates that efficiency improvements accounted for just a quarter of the drop in break-even prices in the past two years.
A fossil-fuel-friendly political climate may not be a great thing, either. Certainly, with the appointment of a pro-oil, climate change sceptic as energy secretary and a former
Neither will financing be quite so readily available this time. Potential lenders, many of which have been stung by the sector's ability to withstand low prices, are likely to be more demanding (or in shorter supply) now that supply has tightened. That dynamic could exacerbate the industry's cost-intensive profile which, despite technological innovations, has resulted in negative free cash flows ever since production started to grow at the beginning of the decade. That's an unsustainable trend, even if average break-even prices have come down from between $60 and $84 a barrel in 2014 to the $31 to $39 range this year. Operators may also find it hard to keep a cap on unit costs, which contributed to a large portion of the drop in expenditure in the downturn and will be harder to contain in a higher oil price environment.
Not an income play
The sector's recent volatility, and its historic struggles with free cash flow, mean US shale-focused companies are not known for their dividends. One exception is
Another UK stock - albeit dividend-free - with assets in the Eagle Ford shale is
Apart from the thousands of laid-off workers, and several lenders, the biggest victims of the crash in crude prices in the US shale industry were drillers in marginal basins, many of whose existing wells are now hitting the flatter part of their decline curve. That - according to analysts at RBN Energy - should make it easier for basins with high initial production rates to contribute to overall production growth, and explains why Diamondback Energy (US:FANG) was prepared to fork out $2.4bn for a large position in the highly coveted Permian basin last month. At $1.2m per well, that looks like a great deal, but more broadly we remain cautious of an oil sector that in the very recent past has been found wanting, after talking up its own book.
For UK investors, it can be a little tricky getting direct exposure to US shale, as most tight oil players finance themselves in their home market. Consequently, readers may find it easier to buy into a US energy-focused exchange traded fund (ETF) or index such as the Ashburton Global Energy Fund I (LU1422756434), which invests in major shale stocks including
Management at UK-listed
Analyst view: Reaching the balancing point
US shale oil production stabilised in the third quarter of 2016, as new wells brought to production equalled the number of horizontal wells needed to keep a constant US shale oil output. Between July and October, this "balancing number" was 450 to 480 wells per month, a figure that requires a detailed understanding of base production declines and new volumes added per well.
The balancing well count differs significantly from play to play. Bakken has a lower balancing point than Eagle Ford, which in turn has a similar balancing point to the Permian Basin shale plays combined. In fact, the Permian Basin shale plays have been offsetting the production drop in the Bakken, Eagle Ford and other shale oil plays by maintaining actual production above the balancing point. Increasing activity and transactions in the Permian Basin shale plays suggests this trend will continue in the first three months of 2017.
Investment in US shale is already very strong, with a sizeable amount of activity concentrated on the Permian Basin plays. Over $22bn was invested in mergers and acquisitions in the Permian fields in 2016, more than in any other area of the world, and a record for the basin. For buyers and investors, the attractiveness of the Permian Basin has been mainly due to its large stack potential, which consists of 12-plus formations already proven to deliver competitive well results at low break-even prices. A vast number of exploration and production companies are already exposed to such potential, and further transactions are expected as companies continue strengthening their Permian position by 'cherry picking' areas from competitors that best match their current portfolios.
Bielenis Villanueva Triana, senior North American shale analyst, Rystad Energy