The surge in shale oil supply has changed previous perceptions of oil market dynamics. The US shale oil industry succeeded in doubling US oil output in a few years, specifically after the 2008 financial crisis and up to 2014.
Shale oil projects differ completely from conventional oil projects in terms of size and the time between project initiation and pumping the first barrel of oil. Shale oil rigs are smaller and project execution typically takes less than a year to start actual production. On the other hand, conventional oil projects consume a lot of resources and require substantial planning; even after taking the decision to start the project, it takes several years before production begins. This is why shale oil can be more responsive to price fluctuations, implying a greater level of flexibility compared to the conventional oil industry.
Another aspect that makes shale oil industry different is the type of companies that operate in it. While major National Oil Companies (NOCs) and International Oil Companies (IOCs) dominate the conventional oil industry (Saudi Aramco and French Total as examples), most firms that are active in shale oil are small-medium sized. This happens because of the nature of the projects: mainly the size, as previously mentioned. In light of these differences, how can we explain the surge in US oil production that took place after the financial crisis and the subsequent years?
To answer this question one must pay attention to US financial conditions in particular, and the global financial conditions in general. Most central banks adopted economic stimulus monetary policies during that period: interest rate cuts and Quantitative Easing (QE). These policies made investors look for better returns on their capital even if it meant investing in risky industries such as shale oil.
With the incoming supply of funds from investors, shale oil firms managed to double their operations in a very short time span. The rapid expansion and growth caused what is referred to as the US shale revolution. This illustrates the risks that the shale industry faces today and the puts a question mark over its ability to withstand the current oil market conditions. When oil prices were around $100, shale oil firms’ debt service accounted for almost 50-60% of operating cash flow during 2012 until mid 2014.
Now with the oil price dropping lower, along with the firms’ cash flow, debt service have gone up to 80%, which has caused tremendous pressure and raised major challenges for these companies. The shale oil industry has become intrinsically linked with the financial sector. Therefore, any financial shocks or changes in the monetary policies of central banks will definitely affect oil supply from the shale industry. This factor add a new dimension when analyzing the oil market outlook and the role that shale oil can play in it.