A rebound in crude oil has sparked concern in some quarters that shale producers might be able to start pumping again, in a move which could potentially reignite pressure in the commodities sector.

Oil surged on May 9 in response to wild fires in Canada's biggest oil-producing region, as well as changes within Saudi Arabia's energy ministry, which had led Asian traders to openly on a more bullish footing.

Some investors, such as T Rowe Price’s David Eiswert, believe the potential for a ‘shale revolution’ has passed with the sector crashing as the oil price fell. However, others believe it could be turning an important corner.

Energy specialist Jonathan Waghorn, who co-runs the Guinness Atkinson Global Energy fund, told Citywire Selector the appetite for shale companies is beginning to grow again but is more centralised among the best positioned companies with the greatest acreage.

'We do not believe that all companies will be able to deliver enough oil to satisfy the market and are therefore happily positioned in cheaper, but still well placed, North American E&P companies,' he said. 

Waghorn added, despite the rise in price, it is still not high enough to justify a sustained increase in drilling activity in North America. However, if oil prices stay in the $30-per-barrel range for much longer it may be harder for shale producers to bounce back significantly.

‘Our estimates and company management commentary indicate that a $60 oil price will be required for activity to pick up and for the current production decline to be arrested. Even then, it will take six-to-nine months for the increased activity to result in higher production.’

Positive performance

Speaking to Citywire Selector, Ashish Kochar and Amit Kumar, who co-manage the Threadneedle (Lux) American Absolute Alpha fund said, since February 2016 they have seen more positive catalysts in the sector.

‘Some of the key players - such as Devon, Marathon, Hess, and Cabot - have all raised combined $5 billion equity in February this year and are now relatively better capitalized unlike the smaller players.’

‘As a result, the market rewarded them and these stocks are up 20-50% since the capital raise. Investor appetite in the shale story further improved as these companies cut back on capital expenditures for 2016.’

However, it is the cost of production which is putting these companies in a strong position. Data from Rystad Energy suggested the US needs $36-per-barrel in order to meet the total cost of producing just one barrel of crude oil. 

This high cost of production has raised questions about the sustainability of US shale operators, despite this Kochar and Kumar said oil production costs for these companies improved 10-15% in 2015 even though oil prices dropped.

‘You combine that with the fact that they have hedged 40-50% of 2016 production and one can argue that these companies now seem to be better positioned to weather a longer oil downturn.’ 

Notwithstanding, Waghorn warned that there will be volatility with shale. ‘Over the last cycle, we estimate that energy equities reflected long term oil prices as high as $80-85 billion (in the late 2000’s)and as low as $45-50 billion (early 2016).’

‘With spot oil at $45 billion, long term oil at $55 billion and the market pricing in only $55 billion, we believe that there is a long term opportunity.’

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