URTeC: 2875019

Global competitiveness of the US tight oil cost curve

Robert Clarke*1, Harry Paton*1. Wood Mackenzie
Copyright 2018, Unconventional Resources Technology Conference (URTeC) DOI 10.15530/urtec-2018-2875019

This paper was prepared for presentation at the Unconventional Resources Technology Conference held in Houston, Texas, USA, 23-25 July 2018.

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Abstract

Lower 48 tight oil plays have established the lowest breakeven prices of new-drill supply projects since 2016. This
has disrupted the oil market, with many high-cost conventional projects being cancelled or delayed as they have
become sub-economic. Conventional breakevens are coming down though, and some older, higher-cost projects are
on the cusp of being competitive with tight oil today. Tight oil supply will face competition from conventional
plays, particularly as tight oil sweet spots become exhausted.

Lower 48 tight oil is currently low cost

Lower 48 tight oil barrels currently comprise some of the lowest cost, new-drill supply volumes in the world. Many
of the best US operators have rapidly evolved into Permian tight oil pure plays, to focus on these low-cost reserves.

Wood Mackenzie models specific tight oil projects for more than 150 US Lower 48 operators. We have constructed
and continually update discounted cash flow asset models for over 500 tight oil assets domestically. The post-tax
breakeven figures are output from those models and are calculated for future wells.

Permian breakevens, particularly in the Delaware Basin, dropped below the US$40/bbl threshold in 2017. Wood
Mackenzie models indicate that tighter cluster spacing was a critical variable in that reduction. Even though the
longer-term impact on well EURs has yet to be fully seen, next-generation completions resulted in much higher
cumulative 180-day volumes and shorter well payback periods.

Large breakeven reductions were also seen in the STACK Mid-continent play, where average well performance
improved as the number of failed completions fell rapidly. We attribute this to better basin models, more robust
multivariate analysis for appraisal projects, and higher pump rates used during completions.

Low-cost barrels today may not stay that way though. Models suggest that future tight oil drilling will become more
expensive. Well designs and completion formulas are no doubt continually evolving, but cost structures moving
forward will be dynamic too with varying degrees of inflation seen across the supply chain. Additional productivity
gains can offset some of this, but technology advancements will be massively critical as sweet spots become
exhausted and less productive reservoir zones become reclassified as core areas.
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Can conventional projects really compete with US tight oil?

US tight oil has completely disrupted the oil market. Many conventional greenfield projects were high cost and
became sub-economic when oil prices crashed, so operators swept them aside.

Recently, we have seen encouraging signs of improvement in conventional project breakevens. Costs have come
down. With a flurry of deepwater final investment decisions (FIDs) at the end of 2017, there is a mood of quiet
optimism in the upstream sector outside the US too.

Key conventional projects have found a way to compete with US tight oil. World-class discoveries in countries such
as Brazil and Guyana with giant reserves and high quality reservoirs have project breakevens lower even than most
tight oil plays.

In other, more mature sectors, like the US Gulf of Mexico or the North Sea, operators have made great progress in
bringing costs down and lowering breakevens too; however, there is still work to be done for many other
conventional projects around the world before they truly compete with the core tight oil plays.

Breakeven comparison for US Lower 48 future drilling and conventional pre-FID projects
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US tight oil dominates volumes

Together, US Lower 48 future drilling and conventional pre-FID projects contribute over 13 million b/d in 2027.

In 2014, we forecast the split of new production 10 years out to be made up of 50% conventional projects and 50%
US Lower 48 tight oil. Models today show the split a decade out at 30% conventional and 70% tight oil.

In fact, the split could be even more weighted to tight oil. Production from conventional pre-FID projects today is
considerably lower than what we forecast pre-price crash. Since 2016, we have seen offshore pre-FID production
volumes increase by just 600,000 b/d. A good part of this is concentrated around the great exploration success story
in Guyana.

A key driver in the ratio change is the large number of uneconomic conventional projects that have fallen
completely out of the cost curve because they were delayed or cancelled. Most projects now in the mix have
changed in scope since first conception too, often subject to a total reworking of development plans. Operator
mentality has shifted to ‘value over volume’. This brings significant cost savings and lower breakevens but removes
a substantial amount of future production for many conventional assets as redesigned projects are smaller.

On a global perspective, where will the US Lower 48 sit on the cost curve?

US Lower 48 is one of the most expensive sources of supply when we move all the way out to 2027. This may seem
surprising given tight oil’s current competitiveness, but higher-cost future drilling will be required to offset declines
from legacy production as core sweet spot acreage is drilled out. This contrasts with conventional resource themes,
which benefit from longer-life assets providing a relatively cheap, stable base of production.

Evolution of the pre-FID cost curve 10 years from dataset

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Why do we need new sources of supply?

The market faces a looming supply gap caused by declining legacy field production and projected growth in
demand.

We recently calculated that non-OPEC onstream declines stabilized at around 5% in 2016. Our analysis suggests
they will stay at this level to 2020 before increasing to historical norms of 6% a year. Combine this with demand
growth of around 8 million b/d and the resultant supply gap is around 23 million b/d in 2027. This will need to be
filled by a combination of:

• US Lower 48 new drilling and pre-FID global conventional projects

• Reserves growth (higher recovery from legacy fields through brownfield development and technological
advances)
• Yet-to-find resources from exploration
• Contingent resources (discovered fields with no current development plan).

By far the largest source is US Lower 48 future drilling and pre-FID projects. These are the future marginal cost
barrels that will play a key role in setting the price in the next decade. Specifically, the Permian drives this.
Technology-enabled plays like the STACK as well as undrilled portions of the mature Bakken and Eagle Ford
contribute volumes, albeit to a lesser extent.

Global liquids production in 2027, by breakeven

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Conclusions

The cost of supply is heavily influenced by tight oil today, but is nonetheless set to increase.

• Growth in low-cost OPEC capacity is not sufficient to offset declines in low-cost non-OPEC volumes.
• Future production is sustained by higher cost (>US$60/bbl) non-OPEC sources. This higher cost non-OPEC
production is set to increase from 1.7 million b/d in 2017 to 5.3 million b/d in 2027 and 9.2 million b/d by 2035.

US Lower 48 transitions to one of the more expensive sources of supply in 10 years' time.
• Higher cost new drilling is required to offset declines from legacy production as core acreage is drilled out.
• Conventional resource themes have a larger base of already producing, lower cost supply.

Conventional pre-FID projects can compete with Lower 48 breakevens.

• To offset existing field declines and demand growth, new supply is still required.
• In 2027, production from US Lower 48 new drilling remains competitive compared with other sources of new
supply, providing 70% of pre-FID volumes.
• Conventional project breakevens now compete with L48, at the expense of significantly reduced volumes, due
to high-grading, deferrals and project redesign.

The US Lower 48 is an increasingly important marginal barrel producer though.

• With reduced volumes in the conventional project hopper, we see greater emphasis on the US Lower 48 as a
short-cycle marginal barrel producer. Small variations in price have a big impact on L48 volumes.