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Crude oil prices may determine future for some shale plays

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Returns from shale plays

As you can see in the graph below, from August to November, returns on drilling wells in shale plays such as the Eagle Ford dropped from more than 20% to the 15% range. Bakken operators may be affected the worst. Returns have gone down by 32% to ~11% returns during this four-month period. Much of the fall can be attributed to the fall in the price of oil. It’s not clear how many operators will find it profitable or economical to produce at this level for a long period of time. Companies need to operate at a return level higher than their cost of capital.

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Why returns vary

Across the shales, the internal rate of return from crude oil production isn’t uniform. The companies operating in the core of the basins typically enjoy higher recoveries at lower costs, while those at noncore areas have higher costs. Therefore, the fall in the price of crude oil should make producers at the noncore shale areas faster than the others. Source rock depth, percentage of resource, and organic content are only a few variables that can affect production rates.

Profitable drilling in Bakken

The Bakken produces high-quality light crude. Several Bakken operators communicated that their drilling project in the Williston Basin required well head prices between $65 and $68 per barrel. With West Texas Intermediate (or WTI) falling to $53 by the end of December, the situation can become challenging for smaller producers.

Returns from the Eagle Ford in Texas and the Bakken shale in North Dakota is an example of how well economics play out in this environment. Bakken drillers such as Continental Resources (CLR) have already announced plans to cut their rig counts in some North American oil fields as crude prices trade near $55 a barrel. Other major Bakken upstream producers such as EOG Resources (EOG) have commented on profitability at crude oil price levels of $80 a barrel. Read the rest of the series to know how upstream companies are responding to falling crude prices.

Other key shales

Some oil producers are investing in other shales. In October, crude oil major Southwestern Energy (SWN) announced it would acquire oil and gas assets from Chesapeake Energy (CHK) in the Utica shale and the Marcellus shale. Some companies such as Halcon Resources (HK) are trying to tap newer shales such as the Tuscaloosa Marine Shale in Louisiana and Mississippi to diversify their shale asset base. Some of these are components of the Energy Select Sector SPDR ETF (XLE).

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