What it means
In conventional production, oil sits in porous rock that lets it flow to a well with relatively little help. Unconventional oil is trapped in rock that is too dense or too thick to flow freely.
Producers need extra techniques, such as hydraulic fracturing (pumping fluid to crack the rock), horizontal drilling, steam injection or mining. The business model is different from conventional fields.
Conventional projects tend to need large up-front exploration and development spending, then produce for many years at a slowly declining rate. Many unconventional wells need a large number of smaller investments and decline quickly in the first years, so a producer must keep drilling to keep output steady.
That pattern makes the cost of each new well and its early output the key numbers. Capital spending is more flexible, because a company can speed up or slow down drilling as prices change, which gives it some natural protection when prices fall.
The trade-off is that it is also more exposed to price swings and to the cost of borrowing. Breakeven price is the common yardstick.
It is the oil price at which a project earns just enough to cover its costs and the required return, and it differs widely between regions and techniques. Investors compare breakeven prices to the market price to judge which producers can survive a downturn.
There are also environmental, regulatory and community issues, such as water use, emissions and local approvals. These can raise costs or delay projects, and finance teams should include them in forecasts.
The term has no single legal definition, so it is worth checking what a company or report means by it. Lenders and equity investors also look at how quickly a company recovers its drilling spend.
A short payback period gives more flexibility, because the cash can be redeployed into new wells or returned to shareholders. A long payback leaves the company exposed if the oil price falls before the investment is recovered.
In practice
Real-world examples.
Example
A tight oil producer plans 50 wells at $8,000,000 each, a total of $400,000,000. Management sets the drilling pace each quarter according to the oil price, speeding up when prices rise and slowing when they fall. The board approves the plan against a minimum return on each well.
Example
A bank lending to an oil sands operator checks that its cost per barrel is below the price it expects over the loan term. It also asks for hedges (contracts that lock in a price) on part of the production to protect repayments.
Example
An analyst compares two producers with similar output. One has a breakeven price of $45 per barrel and the other $65, so she regards the first as safer if the oil price drops. She also checks how much debt each company carries, because borrowing raises the effective breakeven.
Formula
Calculation
Cost per barrel = (Well cost + Lifetime operating cost) / Lifetime barrels produced
A producer drills a well for $8,000,000 and expects $4,000,000 of operating costs over its life. The well is forecast to produce 300,000 barrels in total. The cost per barrel is (8,000,000 + 4,000,000) / 300,000 = 12,000,000 / 300,000 = $40 per barrel. This excludes royalties, taxes and financing costs, so the true breakeven price is higher.Case study
Seen in the real world.
Prairie Ridge Energy is an illustrative, fictional company that raised $300,000,000 to develop a tight oil field. Early wells produced strongly, but output fell by more than half in the first two years, and the company had to keep spending to maintain volumes.
When the oil price dropped, the finance director paused new drilling and focused on the wells already in operation. The company's cost per barrel was $38, so it stayed profitable on existing production, while the lower drilling budget preserved cash.
The illustrative lesson is that unconventional oil rewards disciplined capital allocation. Prairie Ridge later restarted drilling only when forecast prices covered cost and a margin of safety, and it reported its cost per barrel alongside production each quarter. Investors welcomed the transparency, and the company's borrowing costs eased.
Watch out
Common mistakes.
- Treating unconventional wells like conventional ones and assuming a slow, steady decline in output.
- Quoting a cost per barrel that leaves out royalties, taxes and financing, which makes the project look cheaper than it is.
- Ignoring the need for continued drilling, which is required to hold production level.
Questions
People also ask.
What counts as unconventional oil?
Common examples are tight oil from shale, oil sands, extra-heavy oil and oil shale, although definitions vary between organisations.
Why is the breakeven price important?
It shows the price needed to cover costs and a required return, which tells you how well a producer can cope with falling prices.
Is unconventional oil always more expensive?
Not always, because costs vary widely by site and technology, and the best unconventional locations can compete with some conventional projects.
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