BP BP Plc

By Bradley Olson And Erin Ailworth 

The ingenuity and easy money that allowed American oil companies to keep pumping through a year-long price crash appear to be petering out as U.S. crude slides toward $40 a barrel.

U.S. companies have stunned global rivals by continuing to produce oil--particularly from shale deposits--ever more cheaply as American crude prices plunged from over $100 a barrel in 2014. But the recent drop toward $40 a barrel and below puts even the most efficient operators in a bind.

"Forty-dollar to fifty-dollar oil prices don't work in this business," Ryan Lance, chief executive of ConocoPhillips, the largest independent U.S. oil producer, said in an interview.

The worst-case scenario most major producers have discussed in the past six weeks with investors involved a price of $50 a barrel. That is beginning to look optimistic as Saudi Arabia continues to produce near-record volumes and major exporters such as Iraq have increased output. Many oil executives, including BP PLC CEO Bob Dudley, expect prices to be "lower for longer." The U.S. Energy Department is forecasting the price of oil will average around $50 a barrel next year.

More than 250,000 people world-wide have lost their jobs in the industry over the past year, according to Graves & Co., a Houston consulting firm. Many companies that were hoping to weather low energy prices without new rounds of layoffs and salary cuts may be forced to slash those costs yet again, said Eric Lee, an energy analyst with Citigroup.

"Who's going to take the brunt of this? Shale has already cut back a lot, " Mr. Lee said, adding that new oil projects are being deferred around the world.

In a way, he added, oil companies are responsible for the current situation. During brief price rallies, they raced back into fields to drill new wells--adding to the global glut of crude and cutting off the price rebounds. Even as the number of rigs operating in the U.S. fell 60% so far this year, American oil production through August dipped just 3% from its April peak, federal data show.

What happened was a combination of declining costs for oil-field services and equipment and impressive feats of engineering. Companies doubled the amount of sand they pumped into wells, figuring out how to better prop open rock layers to draw out more oil and natural gas. Operators moved rigs into areas where crude flowed the most freely, cut the number of days it took to drill by nearly half and extended the length of horizontal oil wells to reach nearly 2 miles.

Costs for such big wells fell by as much as a third as oil explorers put extreme pressure on the suppliers that help them coax more fuel from the ground, including Halliburton Co. And producers became far more efficient. In the seven most prolific U.S. shale fields, they boosted oil production per rig by as much as 60% this year, according to federal estimates.

That increased efficiency appeared to dramatically improve the outlook for profits even after crude prices plunged from their June 2014 high. But those gains now appear to be tapering off, according to oil analysts. U.S. oil production is expected to fall by more than 5% to 8.8 million barrels a day in 2016, down from an average of 9.3 million barrels a day this year, according to projections from the Energy Department.

The boom in shale-oil production came amid wide open capital markets. As companies ramped up drilling from Texas to North Dakota in recent years, they frequently paid for new wells either with cheap debt or new equity. Investors rewarded production growth, allowing operators to continue drilling even while making little money.

To the surprise of many analysts, that remained true in the first half of this year despite the oil-price crash, as companies issued $11 billion in new equity, according to Dealogic. Since July that has slowed to a trickle of about $2.6 billion, with only a handful of companies trying to tap markets for funding in recent months. Noble Energy Inc.'s effort to spin off some of its pipeline and gas-processing assets was scuttled this week.

Companies are also hitting a wall in terms of cost cuts.

"We're really reaching the limit of what people can do," said Allen Gilmer, chief executive of DrillingInfo, an Austin, Texas company that compiles data on tens of thousands of shale wells across North America. "Right now, you are down to the best areas, the best rigs, the best people. Any cuts from now on are bone rather than fat."

For the past year, energy companies have touted the profitability of their best prospects, explaining their success to investors using the concept of a "break-even" cost, generally defined as the oil price needed to reach a 10%-to-20% profit margin. When oil was trading around $65 a barrel, many top energy executives said they could turn a profit even if the price fell to $60. As costs in the oil fields dropped, those break-even figures fell along with them, making certain wells profitable even at lower prices.

Earlier this month, EOG Resources Inc., a Houston-based shale driller, said some of its most prolific wells would yield a rate of return above 40%, even with U.S. oil prices at $50 a barrel.

But break-even prices don't always give the whole picture of how much money a shale company must spend to pump oil and move it to market. They can exclude land costs, which for some companies amount to billions of dollars, and they don't include the cost of using pipelines to transport crude, according to company financial statements and analyst reports.

In nearly all of its investor presentations this year, EOG has said it can turn a profit at prices at or below the prevailing oil price at the time of the presentation. Yet more than $6 billion in capital spending this year has produced nearly $4 billion in net losses over the past year for the company, which is an industry bellwether.

The company, which has said $40 oil is unsustainable, didn't respond to requests for comment.

EOG isn't alone. In the past 12 months, the 24 largest shale companies have reported losses totaling more than $62 billion and many show negative returns.

Energy companies will be forced to cull billions more dollars from their budgets next year as low crude prices halt drilling around the world, said Dennis Cassidy, the Dallas-based managing director of oil and gas at AlixPartners, an advisory focused on turnarounds. Shale producers with high debt or marginal oil fields will suffer the most, he said, but added, "Everyone is going to feel pain at $40."

Write to Erin Ailworth at Erin.Ailworth@wsj.com

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(END) Dow Jones Newswires

November 20, 2015 19:57 ET (00:57 GMT)

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