Ever since World War Two, U.S. policymakers have been concerned about the nation’s energy dependence on the rest of the world. With the onslaught of skyrocketing oil prices from the 1973 Oil Embargo imposed by Arab members of the Organization of Petroleum Exporting Countries (OPEC), these concerns became significantly more important to U.S. energy security. But, it hasn’t been until the last decade that energy independence has begun to look like a realizable goal and it has much to do with the rise of U.S. shale oil production. While the decline in oil prices over the past year, and OPEC’s decision not to cut production in order to boost prices, are taking their toll on shale oil producers, the U.S. can rejoice in the fact that it may not have to worry about absurdly high oil prices and the instability it creates for some time. (For related reading, see: How Oil Prices Impact the U.S. Economy.)

The Rise of U.S. Shale Oil Production

Since reaching a peak in 2005, U.S. dependence on foreign oil has been decreasing. There are a number of reasons for this decline, including falling domestic consumption and increasing domestic supply. One of the most notable factors concerning supply is the rise of shale oil production, which has been dubbed the “shale revolution.”

Two of the factors that have contributed to the rise in shale oil production have been the relatively high price of oil over the last decade and technological advancements that have made finding and producing oil in shale and tight rock formations significantly more affordable. In a situation of low oil prices and expensive technology to extract oil, shale production makes no economic sense. But a reversal of this situation—characteristic of the last 10 years—makes such production profitable.

In 2005, shale oil production stood at under 500,000 barrels per day. By 2011 production had reached nearly one million barrels per day and began to increase significantly, reaching a peak of over 4.5 million barrels per day by the end of last year. Considering that total crude oil production in the U.S. at the end of 2010 was just under 5.5 million barrels per day and at the end of 2014 it was just over 8.5 million barrels per day, the major source of growth has been shale oil production. (To read more, see: Guide to Oil and Gas Plays in North America: Shale.)

The Fall of U.S. Shale Oil Production

But the shale revolution that helped push U.S. crude oil production to 10.4% of total worldwide crude production at the end of 2013 was a major contributor in undermining one of the very factors that helped fuel that revolution; that factor being the price of oil.

While slowing global demand for oil, especially from China, has been a significant factor in oil’s price decline, the increasing supply from the U.S. has also contributed to the price drop. From 2005 to 2014 the total global supply of crude oil increased by 3.5 million barrels per day, but if one were to exclude U.S. shale oil production, global supply would have actually fallen by about one million barrels per day over this period.

In response to lower demand and increasing supply, in the latter half of last year the oil price dropped precipitously. At the end of June 2014, the price of West Texas Intermediate (WTI), the U.S. benchmark for crude oil prices, was sitting at close to $105 per barrel. Over a year later it reached a low of close to $38 per barrel and currently sits just under $47 a barrel.

Traditionally, OPEC and its de facto leader, Saudi Arabia, have cut production in order to support higher oil prices. Yet, following an OPEC meeting in Vienna on November 27, 2014, it was clear that the cartel was not going to intervene to stop the oil price rout this time. Saudi Arabia explained that it needed to maintain output levels in order to keep from losing market share, especially from U.S. shale producers. (For more, see: How Saudi Arabia Benefits From Cheap Oil.)

With low oil prices it becomes increasingly harder for higher cost production methods, like U.S. shale, to compete with low-cost producers like Saudi Arabia. Last year Reuters estimated that the marginal cost of producing one new barrel of oil for U.S. shale producers was between $70 and $77 whereas Middle East Onshore marginal cost was between $10 and $17. Thus, below $70 a barrel U.S. shale would no longer be profitable whereas Middle East could still reap significant profits. While production efficiency advancements over the past year have some experts arguing that break-even prices could be as low as $30 for U.S. shale producers, such low-cost production is likely only available in the best areas of already existing oil plays.

Without a doubt, U.S. shale oil producers are feeling the effects of low oil prices as the number of drilling rigs has fallen by 62% compared to this time last year. With U.S. shale producers reporting cash outflows of over $30 billion in the first part of this year, shale oil production in the U.S. is likely to decline significantly next year. After domestic output peaked this past April, forecasts suggest that total U.S. crude oil production will decline by 400,000 barrels per day by next year.

The Bottom Line

While U.S. shale oil producers will struggle to stay profitable amidst low oil prices, their rise has significantly changed the economics of global oil production. The very fact that Saudi Arabia and other OPEC members chose not to cut production in order to boost oil prices because they are wary of losing market share suggests that a future oil embargo like that of the 1970s is unlikely. Any attempts to cut production and limit the supply to the rest of the world will quickly revive shale oil production in order to fill the supply gap. U.S. policymakers may be patting themselves on the back for finally attaining a little more energy independence.  

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