Why labor requirements could pose a challenge for US shale oil recovery

September 2016 | Ryan Peacock, Ranojoy Duffadar, and Sam Linder

There is a sense that we are currently at the bottom of the oil price cycle with US onshore, primarily shale oil, among the hardest hit. There is reason for optimism, however, as the short lead times and low per-well capital costs position shale well for recovery when prices stabilize. The key question we see emerging is whether the shale oil industry will be able to meet its labor requirements on time while simultaneously maintaining low break-evens as oil prices recover to a new normal of USD60-70/bbl?

We saw a similar oil price cycle play out in 2008 with the number of active land rigs in the US dropping from over 1,900 in August 2008 to less than 850 rigs by May of the following year. However, this sharp decline in activity was a result of the global recession, which led to a huge oversupply of labor. The US unemployment rates peaked to 10% by the end of 2009.

By 2011, the cycle had recovered as active US onshore rig count neared 2,000, above the 2008 pre-cycle activity levels. This equates to an average of 40 rigs activated per month over a 2.5 year period. The US shale oil industry was able to meet the high labor requirements associated with the rise in rig counts in part due to the high unemployment rate prevalent at the time. Plenty of labor was available, easing the recruitment of workers to the oilfields in North Dakota, Pennsylvania, Oklahoma, and Texas. Furthermore, the swift recovery in oil price above USD100/bbl allowed the industry to offer high wages with little worry of impact to break-evens. Such attractive compensation served to draw employees from other sectors of the labor market.

Exhibit 1: US rig activity and unemployment rates during oil price cycles

SOURCE: Baker Hughes, Bureau of Labor Statistics

This cycle is fundamentally different

The current cycle is developing with a couple of fundamental differences to 2008:

  • In contrast to 2008, the US is currently witnessing a low unemployment rate of 4.9%, driven by healthy job growth in comparable industries such as construction and manufacturing
  • Whereas oil reached sustained pricing above USD100/bbl in 2011, this cycle is unlikely to see nearly the same level of recovery. A USD60-70/bbl pricing is more likely medium-term.

As would be expected, oil and gas companies have been laying off significant numbers of employees to cut costs and weather the storm. To date, ~80,000 announced job cuts have occurred with likely even more that have gone unreported. By contrast, there has been a massive increase in job growth in comparative industries with job losses in oil and gas potentially absorbed by other sectors. Manufacturing and construction alone added close to 150,000 jobs in the last 12 months.

Exhibit 2: Announced layoffs in the oil and gas sector set against job growth in comparative industries

SOURCE: Bureau of Labor Statistics, Challenger, Gray & Christmas

Balancing growth and low cost structure

For the US shale oil industry to get to a new operating level, companies must face the arduous task of balancing growth in operations while maintaining a low cost structure. Companies need to keep break-evens low to remain competitive and capture upside as oil prices recover. A major source of tension emerges; as recovery in oil price will drive increased rig activity, however that activity increases labor requirements. Can the industry add manpower without impacting cost structure?

How willing are former shale workers to move back?

Despite substantial opportunities in other sectors, doubtless some former shale workers will come back, but others may well need to see higher compensation. The last oil price cycle saw salaries grow by about 17% but this is less feasible in the current environment. Added to that, there is considerable uncertainty regarding the stability of jobs in the oil and gas sector. To overcome these challenges, companies will have to attract labor from other competing industries using high remuneration packages, which would imply raising operating costs. However, this is in direct conflict with maintaining a low cost structure since it raises the required break-even price.

The critical challenge for the shale oil industry even if oil recovers to a new normal of USD60-70/bbl will be to manage the interplay between offering higher compensation to attract workers into a volatile market while maintaining a low cost structure.


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About the authors

Ryan Peacock is a Solution Manager and Ranojoy Duffadarand Sam Linder are Diligence and Business Intelligence Specialists, all with Energy Insights in McKinsey's Houston office.