×

How US drillers weathered OPEC's new oil order

All eyes are on Vienna this week as the Organization of the Petroleum Exporting Countries meets Friday to discuss whether members will hold oil production steady, continuing a policy put in place at last year's meeting that accelerated the worst crude price collapse since the financial crisis.

Since then, oil futures have plummeted about 40 percent to the low to mid-$40s. Early projections saw international benchmark Brent crude rebounding by the end of 2015. But just this month the International Energy Agency said it does not expect prices to stabilize at $80 per barrel until 2020.

OPEC's current output policy — largely orchestrated by top oil exporter Saudi Arabia — reverses its longstanding role as the market's "swing producer." Instead of reducing supply in a bid to prop up prices, OPEC members have flooded the market and sought to defend their share.

All 24 respondents in a CNBC survey conducted between Nov 20 and Nov. 30 said they do not expect OPEC to agree to production cuts this week.

Read More This is when oil will hit rock bottom: CNBC Survey

That shifts the onus to producers with a higher cost of extraction, in particular, U.S. shale frackers. Those drillers use a process called hydraulic fracturing, which injects a mix of water, minerals and chemicals deep below the Earth's surface to break up shale rocks and release hydrocarbons that were once unrecoverable.

This technological revolution in American oilfields has largely accounted for a massive increase in global oil and natural gas supply. Much of that increase has come from just a handful of fields, including the oil-rich Bakken in North Dakota and Texas' Permian Basin and Eagle Ford Shale.

OPEC's pivot last year put pressure on American frackers, whose cost of producing oil largely ranges from about $30 to $60 per barrel, but can run even higher. That compares with $10 or less in some cases for Saudi oil.

But U.S. producers have proven far more resilient than once thought. Of course, U.S. production has leveled off after hitting a peak of about 9.6 million barrels per day in April. But output has declined only slightly despite the number of rigs operating in U.S. oilfields collapsing by nearly two-thirds from the heights of last year.

That means U.S. producers are cutting costs but increasing efficiency. At the same time, they've secured discounts from the companies that lease and service oil rigs and other equipment.

Part of the equation is a policy called "high grading," or relocating rigs to the most productive assets in a producer's portfolio.

Most of the cost of a new well lies in drilling and fracking it, so producers are only spending money to bring new production online in places where they're reasonably certain they can extract oil on the cheap.

Read MoreWhy OPEC's plan to balance oil markets backfired

Not only are producers moving rigs to their best land, but they're also completing more fracking stages per well, Charles Cherington, co-founder of the energy-focused private equity firm Intervale Capital.

"That's caused the sort of rollover in U.S. production to happen more slowly than people might have anticipated," he told CNBC's "Squawk Box" on Monday.

Drilling methods have also become more efficient.

For example, drillers are now adopting a hydraulic fracturing method pioneered by companies such as Liberty Resources and EOG Resources that uses larger amounts of water and minerals. While it's a more costly process, it has been shown to boost production rates in the first crucial year of a well's life, after which output drops off dramatically.

Processes such as these have reduced the break-even cost of producing a barrel of oil and kept profitable some acreage that drillers might otherwise have left idle.

Read More Frackers change methods in 'imploding' oil market

The improved efficiency can be seen in the production, per well, in America's oilfields. In December 2008, drillers in the Permian Basin were operating 234 oil rigs and producing 85 barrels per day per rig. Last month, Permian producers had the same number of rigs online, but produced at a rate of 370 barrels per day per rig.

Steady production has also contributed to record-setting stockpiles in U.S. storage facilities as supply continues to outstrip demand.

U.S. commercial crude inventories reached a modern high of 490.9 million barrels in April, according to the U.S. Energy Information Administration. Stocks have recently flirted with those levels as persistently low commodity prices encourage oil market participants to store crude in anticipation of higher prices.

The picture is unlikely to change, with OPEC expected to announce that it will maintain its current policy when the cartel meets this week. Some see oil prices beginning to recover by the end of 2016, but only gradually.

That is raising concerns that prices could suddenly rocket higher some time in the future. In October, Barclays issued a research note concluding that current oil price levels are too low to encourage U.S. producers to invest in bringing enough production online in the medium term, thereby setting up a potential supply shortfall and corresponding price spike.

"The lower oil prices go today, the higher they will likely go in the coming years."

Intervale's Cherington told CNBC that such a reversal may not be far off.

"There's this production hangover now, but if you look forward to 2017 and '18, we're going to have the opposite problem, and you're going to see a real shortage because all this capex reduction today is going to lead to lower output in a couple of years," he said.

"The worse it is and the longer it lasts, the more acute the shortfall will be in a couple of years," he said. "It's kind of ironic."