Is Fracking Worth It if Oil Prices Continue to Drop?

While fracking has the potential to generate huge profits, a recent drop in oil prices has analysts worried that bottom lines could take a serious hit. In the past, hedging oil and gas output has cushioned fracking companies against falling crude prices, with many companies successfully insulating themselves against a recent price plummet that saw West Texas Intermediate slip to a low of US$53.43.

While the price drop has triggered a temporary high for fracking companies, analysts warn that in the face of a long-term price drop profits could be compromised and future drilling projects may be cancelled.

The ups and downs of hedging

For much of 2018 hedging proved to be a drag on profits, with many companies unable to harness the spike in oil prices. However, oil is now retailing at lower than the average hedging price, which means shale drillers could stand to benefit from existing derivatives contracts. That said, not all production is protected against price swings, with many hedging contracts set to expire in 2019. This will leave just 25% of output protected by derivatives contracts, compared with 45% in 2018. If the price drop continues it could force shale drillers to slash capital spending plans in 2019 and reassess investment opportunities.

“Lower oil prices could mitigate some of the growth ambitions companies previously had,” says Andrew McConn, an analyst at Wood Mackenzie.

Saturation set to threaten US oil market

There won't be a shortage to push up prices, with the Energy Information Administration predicting US oil production will top 12 million barrels a day next year. In response, companies like EOG Resources Inc are closely watching prices and factoring developments into 2019 spending plans. If oil dips below US$50 a barrel, the company plans to scale back production.

“We’re going to maintain our discipline in how we allocate capital,” confirmed chief operating officer Lloyd Helms, Jr. “We’re building a business that’s going to be sustainable through the commodity price whether the oil price is $40 or $80.”

A domino effect for drillers

Other experts warn that a sustained oil price drop could disproportionately influence drilling activities in places like Canada and North Dakota, where producers are disconnected from export markets and forced to discount crude in response to pipeline bottlenecks.

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