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Analysts: OPEC deal to revive shale

by Jessica Seaman | December 6, 2016 at 5:45 a.m.

U.S. energy companies, after struggling with low oil prices for two years, are expected to ramp up drilling activity in the oil patch again.

The recent agreement by OPEC to remove 1.2 million barrels a day from the market has the ability to boost oil prices to levels that would entice companies into pumping more crude, analysts said.

"There's no doubt that they are going to be coming back online," said Phil Flynn, an energy analyst with Price Futures Group.

But, he said, "It's not going to happen overnight."

The agreement by OPEC last week reverses a two-year strategy in which the cartel sought to place pressure on U.S. shale producers in order to remain dominant in the oil market and dissuade others from putting too much crude online.

When oil prices first tumbled in 2014 after a global oil glut, the Organization of the Petroleum Exporting Countries kept pumping crude even as the downswing in the oil market threatened to throw some members' economies into turmoil.

The move, led by Saudi Arabia, triggered a so-called price war aimed at curtailing U.S. production, which had surged during the nation's shale boom.

The decision to forgo a production cap also shifted away from OPEC's traditional practice of stabilizing prices. In the past, the group would force prices higher by cutting production or lower prices by releasing more oil on the market.

"The decision to maintain production in the face of accelerating U.S. development was logical, but it placed an increasing fiscal burden on OPEC nations," said Adam Fackler, senior research analyst for Miller Howard Investments.

"While the decision slowed capital investment, decimated the U.S. rig count, and forced U.S. production to roll over, I suspect Saudi Arabia was surprised by the resiliency of the U.S. oil and gas industry," he said. "Two years into its campaign, the math behind a production cut simply became too enticing."

Oil prices have surged since OPEC agreed to trim production, with prices reaching a 16-month high Monday.

West Texas Intermediate crude rose 11 cents to $51.79 a barrel on the New York Mercantile Exchange. Brent crude gained 48 cents to $54.94 a barrel in London.

The resurrection of American shale formations will be slow. Companies will be recovering from the oil slump, which forced many to file for bankruptcy, lay off tens of thousands of employees and idle drilling rigs.

When companies do add more drilling rigs, they will look to areas with the lowest break-even costs, such as the Permian basin in Texas, analysts said.

The Fayetteville Shale in Arkansas, which only produces dry natural gas, will not see a large boost in activity as companies will be focused on drilling in oil formations, which are more profitable, said Michael Lynch, president of Strategic Energy and Economic Research Inc.

By increasing drilling too quickly, U.S. companies also run the risk of adding additional supply to an already bloated market. Energy firms will want to make sure OPEC sticks to its production cuts before increasing output, analysts said.

"The biggest question for the shale producers is: Will members of OPEC actually enact the cuts they agreed to?" said Andrew Lipow, president of Lipow Oil Associates LLC.

"Members of OPEC tend to cheat on production quotas because each of them need the money to finance their government budget," he said. "Unfortunately, the oil industry over here are continuing to be looking to OPEC to see how well they are going to comply with their agreements."

Business on 12/06/2016

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