The explosive production growth in the U.S. shale patch has surprised even the most optimistic forecasters, but the huge jumps in output belies and obscures the financial state of the industry, which is a bit more complicated than the production figures might suggest.

Shale companies scrambled to cut costs during the oil market downturn between 2014 and 2017, and they successfully lowered their breakeven prices significantly. When OPEC+ agreed on its initial production cut deal, which started at the beginning of 2017, the higher prices that resulted from the agreement allowed U.S. shale to rebound in a big way. Surging production over the past two years suggested that the shale industry was stronger than ever.

This year was supposed to be the year that the money started rolling in – with cost cuts in hand and higher oil prices lifting all boats, shale drillers were supposed to be in the clear. But profits have been elusive.

To be sure, some companies have posted significant earnings. The oil majors, in particular, are earning more money than they have in a long time. But the bulk of the shale industry is still struggling. According to the Wall Street Journal, the 30 largest shale companies earned a rather marginal $1.7 billion combined in 2017.

The latest meltdown in prices, however, puts a lot in the industry right back into hot water. The problem is that despite boasts of low breakeven prices, many shale companies have failed to take a comprehensive look at the all-in costs of producing oil, as the Wall Street Journal points out. Related: Is This The Next Disaster For Canadian Drillers?

It wasn’t uncommon over the last few years to hear shale executives brag about how their wells were profitable even with oil under $40 per barrel. But often those figures didn’t include the cost of land acquisition, or transportation. Or, while individual wells might make a return, the company was ignoring the cost of producing in other less desirable locations. At the end of the day, much of the industry was not turning a profit, even when oil prices traded north of $50 per barrel.

According to the Wall Street Journal and consulting firm R.S. Energy Group, true breakeven prices that incorporate costs such as land acquisition come out to about $51 per barrel in the Permian, $57 per barrel in the Eagle Ford, and $64 in the Bakken.

That means that the latest downturn in oil prices is likely putting the industry under strain. WTI is now trading in the low-$50s per barrel.

On top of that, the pipeline bottlenecks are having a negative effect on finances, even though the robust production figures reported by the EIA suggest that the constraints have only had a marginal impact on production.

There are conflicting signals on how much the Permian, for instance, is seeing a slowdown because of pipeline issues. “The widely-predicted movement of activity and capex out of the Permian Basin while off-take capacity is constrained is yet to materialise,” Standard Chartered analysts wrote in a note, adding that “oil rigs in the Bakken have only risen by six y/y, Eagle Ford oil activity is up 13, while the combined Delaware and Midland Basin oil rig count is up 95 y/y.” Related: Iran: Oil To Fall To $40 If OPEC Fails To Reach Deal

But Schlumberger, the largest oilfield services company in the world, said this week that it expects drilling activity to slow down significantly in the fourth quarter, with sales for its services in North America expected to drop by 15 percent, compared to the prior quarter. The recent downturn in prices is hurting drillers, which comes at a time when budgets are mostly exhausted anyway.

“We are seeing a significantly larger drop in activity than we expected, which is leading to a larger drop in pricing than we anticipated,” Patrick Schorn, executive vice president at Schlumberger said in an investor presentation, according to Bloomberg. “We continue to see the weakening of the hydraulic fracturing market as temporary, with the expectation of a gradual recovery taking place over the first half of 2019.”

The financial strain may also be a hiccup that the industry can overcome. Wall Street has showered drillers with cash over the past decade or so. The near-zero interest rate environment allowed for a debt-fueled drilling boom. In other words, unprofitable production barely slowed down the industry in years past. It’s not clear that the latest fall in prices would seriously deter more drilling, even if companies are not making a profit.

By Nick Cunningham of Oilprice.com

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