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Shale oil industry a 'Ponzi scheme' or can it boom again?

Oil prices are rallying on the back of a drawdown in U.S. crude oil inventories but analysts are questioning whether the country's shale oil industry can ever boom again.

On Thursday, Brent oil futures climbed above $50 a barrel for the first time in nearly seven months, having gained as much as 2 percent in the previous session after U.S. government data showed a larger-than-expected drop in crude inventories. The drawdown in crude oil inventories has led to hopes that a global glut in oil supply that has caused prices to plummet since mid-2014 could be finally working its way out of the system.

The sharp decline in oil prices, which has been exacerbated by major oil producers such as OPEC refusing to cut production, has claimed many victims in the oil industry over the last two years, particularly in the U.S. where the shale oil industry has seen many producers cut and close down production.


A floorhand works on an oil rig in the Bakken shale formation outside Watford City, North Dakota.
Getty Images
A floorhand works on an oil rig in the Bakken shale formation outside Watford City, North Dakota.

With prices rising again and many oil market analysts forecasting a gradual, if not entirely smooth, rise in prices over the next couple of years, attention has turned to whether U.S. shale oil production will bounce back like before – or whether it even had solid enough foundations to begin with.

Dominic Haywood, an oil analyst at Energy Aspects, told CNBC on Thursday that "there will be a lot of guys (U.S. shale oil producers) that don't come back into the market. I think we've already lost around 35 to 40 independent shale oil or shale oil and gas producers and those producers won't come back," Haywood said. "They would need about a $70-$80 barrel of oil to cover drilling, extraction and capex costs," he said.

'Ponzi scheme'?

There were high hopes for shale at one time, with widespread expectations that the decline in oil prices could enable the U.S. to be energy independent by 2020, but that is looking more of a pipe dream for now.

The U.S. produces around 9.2 million barrels a day of oil, according to the latest available government data from February, 320,000 barrels less than the same month a year before. Remarking on the data, the International Energy Agency (IEA) said it was in "stark contrast to just one year earlier, when output was growing by 1.3 million barrels a day. Preliminary indications for March and April suggest output continued to fall, as producers removed another 72 oil rigs from service over the past 10 weeks." In the meantime, U.S. net imports totaled 7.3 million barrels in February showing that the dream of energy independence is far off.

Read MoreIs the American dream of energy independence dead?

One analyst told CNBC that he doubted the very foundation of the U.S. shale oil industry which he said had been founded and expanded on cheap money and had effectively been a "Ponzi scheme" – an investment operation that generates returns for older investors by acquiring new investors.

"I think in ten years' time someone is going to write a great book and make a great movie about the shale industry in the U.S. because I think it is, quite frankly, one of the biggest Ponzi schemes known to mankind," Gavin Wendt, founding director & senior resource analyst at MineLife, told CNBC on Thursday.

"You had an industry that evolved there that put forward a huge amount of extra oil production that was pretty much financed by cheap Fed (U.S. Federal Reserve) money, brokers pumping money into the industry, drilling contractors and companies that were, in many instances, not even necessarily producing a lot of oil but were real estate players; for the first time you had companies with enormous valuations that weren't producing oil but were valued on the basis of their acreage," he noted.

"That industry sustained itself for a while until a few people started having a good close look and the key (turning point) was the drop in oil prices which has made 80 percent of the industry un-economic at a price level below $50-$60 a barrel."

Unsustainable business model?

Energy Aspects' Haywood said it was a bit "outlandish" to call the shale oil industry a "Ponzi scheme" but noted that at one point "everyone wanted a piece of the shale oil industry" and that shale production companies' strong acreage positions when oil prices were high had meant that their assets were indeed "very valuable."

"Since then, we've seen oil prices drop and a lot of that acreage become unprofitable so banks have slashed what they're willing to lend," he said. "It's a bit outlandish to say that the shale oil industry is a 'Ponzi scheme' – I mean, lots of businesses out there have operations funded through debt and we wouldn't call them all Ponzi schemes would we?"

He noted, however, that the way many shale oil producers were funding operations with debt rather than cash flow was "clearly an unsustainable model."

With U.S. shale oil producers having higher costs than their foreign rivals, oil price per barrel is a key factor of whether the shale industry can sink or swim. There are fears too that if the oil price rebounds too quickly, too much shale oil production will come back onto the market, damaging a slow rebalancing of supply and demand that is helping to stabilize prices.

Wendt noted that "the big question is of course going to be what is going to happen when we see sustained higher prices," he said.

"My firm conviction is that a lot of that sidelined shale oil supply won't return to the market. I think that's providing confidence to the market and that's reflected in the oil price that's currently trading above $50 a barrel."