13/09/2017 09:23 AST

Shale oil production is seeing a recovery this year due to higher oil prices, and many in the industry forecast that producers will do well next year.

Saudi investment bank Jadwa Investment has however identified four risks that shale oil producers will confront next year that may affect the level of their output developments. The first is the higher cost that shale producers face.

Despite a downturn in shale oil output in 2016, productivity gains and cost reductions helped producers maintain output at levels higher than some expected. Falling oil prices resulted in increased rig productivity, heavy cost-cutting measures and technological improvements, which drove down break-even prices of shale oil production.

One area in which costs are likely to rise is related to oilfield services, which includes the cost of rigs, equipment and personnel. Therefore, despite shale oil operators cutting costs in the last two years, not all of these reductions will be able to be carried forward.

“As a result, break-even prices of shale oil are projected to rise for first time in five years in 2017, to an average of $36.5 per barrel, although they are still 50 percent lower than their peak in 2012,” Jadwa said.

The second risk is that of higher debt costs.

Shale oil companies engaged in borrowing from high-yield debt markets face an even higher exposure to rising debt-servicing costs. In most cases, small-to-medium sized operators have turned to high-yield debt markets, and, “as we have highlighted above, this segment of finance has rebounded recently, with outstanding debt rising by $128 billion in last three-and-a-half years.”

Consequently, the ability of such smaller companies to service principal and interest payments, as interest rates rise, will become increasingly difficult. “Such a situation could, in the very least, reduce the amount of cash available for investing in drilling oil, and, at worst, result in another round of defaults and bankruptcy filings. The situation would, of course, be compounded if oil prices fell further below current levels,” Jadwa said.

The third risk involves oil prices falling further.

Jadwa said that there is a risk of low oil prices next year if the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC countries engaged in cuts decided not to extend their agreement and revert to their October 2016 production levels after the deal expires in March. The result of this would be a global oil balance surplus of 1.3 million barrels per day (bpd) and that would be expected for the whole of 2018. Such a situation would put pressure on prices and the situation would be even more worse than before, Jadwa said.

The fourth factor identified by Jadwa is that of hedge risks.

The latest available data shows that only 466,000 bpd of shale output has been hedged in 2018, with a declining number of hedges through to 2020, Jadwa said. If prices were to decline, “then we would expect to see a slow down in hedging activity through to 2020,” Jadwa said.

“Conversely, a rise in oil prices would encourage additional hedges at higher price levels, to be taken out.”

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