Breakeven Prices -- What It Means For Shale -- Research -- May 21, 2019.

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Data points:

• in the Permian: ranged from $23 to $70/bbl
• not all basins are created equal
• there is a very close and interesting connection between average breakeven prices and the long-dated West Texas Intermediate futures contract
• larger quantities of oil are economical to produce at much lower prices than would have been possible before
• shale production means there is a much larger amount of supply that can be called into action given a much smaller price increase than in the past
• strong forces should keep long-dated futures prices from rising too high or falling too low
• shale production is likely to be a major driver over the next five years

Narrative:

How should we interpret the long-dated futures price of oil? In theory, if the oil market were perfectly competitive, the long-dated futures price should equal the marginal cost of supply—the cost of producing one additional unit—needed to meet long-run demand.
In reality, while it is true that most producers in the oil market are price takers—they produce a small amount of oil relative to global supply and their product has minimal differentiation—the oil market is not perfectly competitive: OPEC can add or withhold production because it operates with spare capacity. Nonetheless, there is still good reason to believe the long-dated futures price will have a close connection with the marginal cost of supply. Rising U.S. shale production—likely to be a major source of incremental supply in coming years—has significantly affected the marginal cost of supply, providing a plausible link between the Dallas Fed average breakeven price and the long-dated futures price.

Horizontal drilling and hydraulic fracturing have made accessible significant amounts of oil reserves previously considered uneconomical to develop. Moreover, production costs for those reserves have declined dramatically over the past 10 years. More generally, companies have sought to lower costs associated with other, more traditional onshore and offshore oil holdings. As a result, larger quantities of oil are economical to produce at much lower prices than would have been possible before.

Over the past 10 years, oil cost curves have moved from being very steep to having a long, flat portion between $50 and $60 as the industry has added resources and as costs have declined . In other words, shale production means there is a much larger amount of supply that can be called into action given a much smaller price increase than in the past.

While market participants may differ on how much oil is available at a given price, they are all aware of the overall trends. These represent strong forces that should keep long-dated futures prices from rising too high or falling too low. Similarly, breakeven prices reported by Dallas Fed Energy Survey participants reflect the principal trends involving the marginal cost of supply in the oil market.

Given current market prices, U.S. shale production will continue growing this year. Indeed, a recent report by the International Energy Agency highlighted that shale production is likely to be a major driver over the next five years. This does not rule out the possibility of major oil price movements, but it does point to a strong tendency that oil prices will be range bound in the near future.