How US independent oil operators must rethink their strategies

08 November 2018 7 min. read
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As a result of the shale oil boom, the US has become an oil exporter. The shifting environment has created new challenges for the oil & gas industry, as Bob Peterson, a Partner at Arthur D. Little, explains below. The challenges include finding new partnerships, commanding and maintaining a price premium, collaborating effectively, and attracting capital. 

The development of shale oil and gas production in the US has been truly miraculous. It can be credited to the combination of innovation, well-developed infrastructure, and readily accessible capital markets. As a result, shale production increased from nil to about 4 million barrels per day between 2008 and 2014 – and by 2022, it is poised to add another 4 million barrels per day, largely from the prolific Texas/New Mexico basin called the Permian. At that point, US production in the Permian alone will equal that of a large OPEC producing country such as Kuwait or Nigeria.

Because of this dramatic increase, the US has become an oil exporter, having moved some 2 million barrels per day already in 2018. Most of the new Permian oil is expected to be exported, but to what markets, and at what price? Maintaining a leadership position in production will require developers to make significant changes in their behavior and capabilities. They must consider and manage a number of complex issues, including establishing global markets, finding new partners, collaborating more effectively, and attracting new sources of capital.


Independents are just that: “independent,” specifically from owning refining and marketing operations. As a result, these companies sell their oil at the wellhead and move on to the next drilling campaign. It is a simple world, but a risky one as the US becomes a major exporter and competition rises in global markets such as Latin America and the Pacific Rim.

Permian forecasted production growthIn this environment, the “drill, sell direct at the wellhead, repeat” behavior will need to change if independents want to maximize steady cash flow. They will need to comprehend and exploit global markets, just as Canadian heavy oil producers have done with excess heavy production. For example, in order to cover shortages in input by Reliance, an Indian oil and gas refiner, Husky and Devon have entered into long-term oil supply arrangements, in exchange for a slight price premium on the heavy oil index.

Commanding and maintaining a price premium

Under the traditional model of selling oil at the wellhead, independent producers have become accustomed to success without factoring in fluctuations in the global markets. Those days are gone, as regional pricing spreads will certainly impact producers’ ability to stay predictably profitable.

Consider the widening gap between the two primary benchmarks for the pricing of oil, West Texas Intermediate (WTI) and Brent light, a North Sea-based index. Since the advent of shale, WTI has traded at a discount to Brent as steep as $10/barrel (2011–2014), which largely reflects the lack of “take-away infrastructure” as production has ramped up in North America. As Permian production once again now exceeds take-away capacity, a separate Permian discount has arisen. This discount, now at $25/bbl, may persist well into 2019, dramatically affecting Permian profitability.

Independents can stay ahead of the pricing fray by identifying and establishing strategies for not only reducing that discount, but also realizing premiums for their oil in some cases. These players will need to develop new export-shipping capacity at ports such as Brownsville to alleviate the growing bottlenecks at Houston and Corpus Christie. Additionally, new, dedicated pipelines for ultra-light Delaware basin production can avoid blending with lower-quality crude and command premium pricing. Finally, independent operators with sophisticated trading capabilities can take advantage of short-term WTI pricing variations by timing hedge puts and calls with “on-demand” well completions – similar to the strategy that Shell is currently following.WTI & Brent Spot Price FOB forecast

Operator collaboration

According to a recent Arthur D. Little study on production growth challenges in the Permian, “Permian Production Constraints, 2018–2022”, more than 41,000 wells, at a total capital cost of approximately $300 billion, are planned over the next five years. The demands on infrastructure will be tremendous. Trucking, roads, water usage, power consumption, and sand to frack the wells, as well as community services such as housing, schools, and hospitals, will all be necessary to sustain rapid development. By ADL’s estimate, about 1 million barrels per day in production growth are at risk due to the inability of the local infrastructure to support daily operations.

As one example, the Wall Street Journal estimates that as activity increases, 120,000 truckloads of sand will be hauled within the Permian on a road system that was built to handle less than 1,000. Considering that this figure does not account for the water and chemicals that will also need to be transported in and out of the area, this is clearly unsustainable. It offers an opportunity for operators to pool capital and planning to build a robust road system, which would also reduce trucking demand by 10 to 20 percent.

Feeding the capital machine

While building out the Permian requires collaboration, it also calls for a massive influx of capital. This is perhaps the greatest challenge in the basin. To provide potential solutions, operators have to think more creatively about funding structured projects. Pioneer’s proposed power generation scheme offers a strong example in this case. The company seeks to pool operator electric power demand as an incentive to infrastructure investors.  In return those investors such as insurance companies, retirement funds and family offices receive a 20-year, low-risk annuity-like return.

Permian forecasted production growth vs. selected exporting countries

Similar projects have already become commonplace in the pipeline space, but these practices must expand to areas such as water management, community infrastructure, roads, and transportation to enable sustainable development.


The development of the Permian basin is a challenge unlike any yet encountered in the global oil industry: to grow production to exceed that of all oil-exporting countries except Saudi Arabia and Russia in less than five years. It is uncertain whether this challenge can be met. It demands that US independents go against their nature by collaborating in key areas. It requires establishing new global markets, building new partnerships to a level not yet seen in the sector, and giving up control of traditionally competitive capabilities in order to attract the necessary investment capital. Forward-thinking players will change the way they do business, giving rise to a new ecosystem that will be able to capitalize on current opportunities and create new avenues for growth.

About the author: Bob Peterson is a Partner in the Houston Office of Arthur D. Little. Peterson is the North America Energy Leader of the international management consulting firm.

Related: US overtakes Saudi Arabia to have largest recoverable oil reserves