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Is this the beginning of the end for Royal Dutch Shell plc and BP plc?

Over the past 10 years, the oil industry has changed dramatically. Technological advances have helped reduce the cost of extracting oil from unconventional sources significantly, and as oil prices have plunged over the past two years, shale oil producers have ploughed more time and resources into pushing costs even lower.

As a result of this unrelenting drive to reduce costs and improve efficiency, it’s estimated that the majority of US shale fields can break even with oil at $60 a barrel. Scott Sheffield, the outgoing chief of Pioneer Natural Resources claims that Pioneer’s pre-tax production costs have fallen to $2.25 a barrel.

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Shale oil producers have also been able to reduce the amount of time it takes to get an oil well into production to around 150 days. In comparison, the oil industry’s traditional deepwater projects can take decades to bring on-stream.

Put simply, over the past few years shale oil producers have become more efficient than ever before, and this is terrible news for traditional oil giants Shell (LSE: RDSB) and BP (LSE: BP).

New swing producers 

North American shale producers have emerged as the oil market’s swing producers. If oil prices rise these producers can quickly bring production on-stream to make the most of the increased demand. Unfortunately, with an army of swing producers standing ready to help equalise supply and demand as soon as a market imbalance appears, oil prices are likely to remain depressed for the foreseeable future.

This is bad news for BP and Shell. These two oil giants have invested billions in complex offshore oil production facilities, commissioned when oil was trading at $100 a barrel and are unlikely to be economic at current prices. Moreover, these oil giants have more new offshore developments in the pipeline.

A report from think tank Chatham House published earlier this year summed up the risks Big Oil companies like Shell and BP face in today’s new oil world. In the past, Big Oil’s response to lower oil prices has been to rein-in new drilling, cut costs, and wait for prices to rise again. Chatham House’s report warns that this time around the old playbook may not work as the oil markets are “going through fundamental structural changes driven by a technological revolution and geopolitical shifts.

The beginning of the end? 

It looks as if Shell and BP are going to have to change their ways to succeed in the new normal oil world. 

Shell has a substantial North American shale oil production arm, but this is hardly going to be enough to help the company ride out the storm. The group’s £35bn deal to buy BG Group was a huge gamble on deep water oil production, although it also gave the group a market-leading position in LNG trading.

Meanwhile, BP has cut costs by $5.6bn over the past two years and expects to cut another $7bn in overheads next year — significant figures that imply BP is already shrinking rapidly.

Still, only time will tell if this is the beginning of the end for Big Oil, it all depends on how the industry adapts to the changing oil environment over the next few years. 

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Rupert Hargreaves owns shares of Royal Dutch Shell B. The Motley Fool UK has recommended BP and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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