[Choi Ji-woong's Energy War] Why Shale Oil Production Does Not Increase Despite High Oil Prices

The Oversupply of Shale Oil That Caused the 2015 and 2016 International Oil Price Crash
This Year's Unusual Phenomenon: Prices Exceeding $80 per Barrel but Production Not Increasing

Shale Oil Companies Fail to Appeal to Investors as Growth Stocks
Oil Companies Lose Appeal Due to Price Crash and Performance Decline During the COVID-19 Period

Asia Economy Newspaper publishes a monthly Thursday column titled 'Choi Ji-woong's Energy War,' diagnosing the energy industry undergoing a great transformation and examining the related changes in the international order. The author is an expert in the energy field who joined Korea National Oil Corporation in 2008, worked in the Europe & Africa Business Division and the Stockpile Business Division, and completed an MBA program in Oil & Gas at Coventry University in London in 2015. He published the bestseller "How Oil Rules the World," which covers the modern history of oil. Last year, he gained readers' attention by serializing the column in this newspaper.

The biggest news in the oil market since 2000 was undoubtedly the emergence of U.S. shale oil. U.S. shale oil production, which was less than 1 million barrels per day in 2010, exploded over the past decade, reaching 8 million barrels per day in 2019. This was an enormous volume, accounting for more than two-thirds of U.S. crude oil production and about 8% of global crude oil production.

The emergence of shale oil caused a tectonic shift in the oil market. It led to oversupply in 2015 and 2016, causing international oil prices to plummet. This triggered the formation of a new oil-producing group, OPEC+ (a consultative group of OPEC member countries and non-OPEC countries including Russia), alongside the existing Organization of the Petroleum Exporting Countries (OPEC) centered on Middle Eastern oil producers. OPEC+ agreed to new production cuts at the end of 2016. That agreement has been extended continuously and remains in effect today.

Even in 2018 and 2019, when OPEC+ continued production cuts, shale oil maintained explosive growth with an average annual increase of about 1.4 million barrels per day. It was truly a shale revolution. In 2018, the U.S. surpassed Saudi Arabia and Russia to become the world's largest oil producer. This led to debates within OPEC+ about the futility of production cuts, as the gap left by OPEC+ cuts was filled by U.S. shale oil. The dissatisfaction that the U.S. was reaping the benefits of production cuts led to the suspension of cuts in March 2020. Russia refused to agree to production cuts, and Saudi Arabia responded with increased production, causing oil prices to plunge. The global media called this the "oil price war." However, a mutually destructive war could not last long. Within about a month, OPEC+ returned to production cuts. At that time, U.S. crude oil production also sharply declined by nearly 20% compared to the previous quarter due to the direct impact of COVID-19, naturally joining the production cuts.

However, a peculiar phenomenon has appeared this year. Since the second half of last year, oil prices have continued to recover, recently surpassing $80 per barrel. Despite oil prices exceeding pre-pandemic levels, the shale industry has barely increased production. According to the U.S. Energy Information Administration (EIA), U.S. crude oil production in the third quarter of this year was 11.06 million barrels per day, only about 3.6% higher than the second quarter of last year when COVID-19 occurred. During the same period, West Texas Intermediate (WTI) crude oil prices nearly tripled (from an average of $28.5 in April 2020 to an average of $80.5 in October 2021). Despite high oil prices being a good opportunity to increase profits through production increases, shale production remains at levels similar to last year.

In early October, Vicki Hollub, CEO of mid-sized oil company Occidental, said they would focus on increasing margins and dividends rather than production and would not pursue growth as in the past. Another shale oil company, Pioneer, also stated that high oil prices would not affect shale industry production and that they would focus on expanding dividends and repaying debt. What exactly is causing shale oil companies to exercise such strict restraint?

The first reason shale oil companies maintain production levels is that they can no longer appeal to investors as growth companies or growth stocks. New investments to expand production in sectors with social consensus on future growth potential can raise a company's stock price. However, to today's investors, the oil industry is not an industry spotlighted as a future leader like 5G or artificial intelligence (AI). Rather, investors' attention is focused on electric vehicles and battery industries, which are expected to reduce oil demand. In this situation, shale oil companies appealing as growth companies by increasing investment and production as in the past is unconvincing.

▲Choi Ji-woong, Researcher at Korea National Oil Corporation Smart Data Center

The second reason is last year's nightmare. The fatal risk for oil companies is that their performance depends on oil prices. This risk was starkly revealed last year. In April last year, mid-sized shale oil company Whiting Petroleum filed for bankruptcy protection, followed by Chesapeake in June. Chesapeake, in particular, was one of the leading companies pioneering hydraulic fracturing, a core technology of the shale revolution, which shocked investors.

Companies maintaining a certain level of debt issue new bonds to repay existing debt when corporate bond maturities come due. If this refinancing process does not proceed smoothly, the company cannot continue. Therefore, to continuously attract investors and sustain business, a company must either show a rosy future with tremendous expected growth or present reasons for investment by maintaining stable, secure profits like a "steel rice bowl."

The oil price crash and performance deterioration during the COVID-19 period caused oil companies to lose their appeal from a stability perspective. Furthermore, the carbon neutrality trend has deepened doubts about long-term oil prices, raising questions about whether the oil industry can sustain growth as in the past. Due to the oil price decline, major oil companies recorded significant net losses last year. Chesapeake also saw a sharp increase in losses in the first quarter of last year due to COVID-19 and incurred about $8.5 billion in asset impairments. Ultimately, Chesapeake failed to persuade creditors and filed for bankruptcy protection.

In this situation, if capital expenditures are increased relying on the oil price cycle but variables such as COVID-19, inflation, and carbon regulations cause demand to enter a downward cycle, investors may massively withdraw. Therefore, current shale oil companies aim to transform their identity into investment destinations that maintain stable sales and profits. They do not pursue growth but seek to maintain high dividends and sound financial structures through stable cash flows. They also appear to be reducing the debt levels that increased during the growth period of the past decade.

This phenomenon implies that the shale oil industry's market influence may weaken. The reason shale oil was a major factor in oil price fluctuations over the past decade was that it was an unprecedented new volume. This unprecedented volume entered the market at a frightening speed, shaking the existing order. However, shale oil is no longer a rolling stone but has settled as a fixed stone. Now, shale oil companies aim to become companies that maintain steady production and profits regardless of cycles, rather than high-risk, high-return growth stocks.

This situation has implications for Korea. Responding short-term to uncontrollable variables like oil prices may not be the right way to address the fundamental risks of oil prices. Domestic energy companies also need to steadily develop capabilities related to energy resources from a long-term perspective. The need to prepare for oil price fluctuations and supply-demand instability will only grow during the energy transition period.

This content was produced with the assistance of AI translation services.