U.S. oil producers are raising capital spending and activity this year, but they have to contend with surging inflation as cost pressures intensify.
While oil production growth picked up the pace in the fourth quarter, costs jumped sharply for a third consecutive quarter to a record-high reading among oilfield services firms "suggestive of significant cost pressures," the Dallas Fed Energy Survey for Q4 found.
In 2022, part of the higher capital spending in the U.S. oil industry will be because of cost inflation. This will not be the highest portion of the increased expenditure, but it will contribute to an overall higher capex this year compared to the previous two years of frugal spending.
As many of the drilled-but-uncompleted (DUC) wells have been exhausted throughout 2021 when companies largely abstained from new well drilling until they go through the DUC inventory, the industry will have to spend more on drilling in 2022.
"Add rapid cost inflation into the mix, and capital spending could rise by almost 20 percent just to maintain production at the same level as last year," warned the Institute for Energy Economics and Financial Analysis (IEEFA) oil and gas analyst Trey Cowan, and energy finance analyst Clark Williams-Derry.
"These cost increases will land first on oilfield service firms—who may not be able to pass the costs on to producers," Cowan and Williams-Derry noted.
A total of 72.1 percent of oil and gas support service firms reported an increase in input costs in Q4, compared to just 2.3 percent that reported a decrease in input costs, according to the Dallas Fed survey. At the same time, the prices received for the services remained unchanged for 65.1 percent of the oilfield service firms in the survey.
The services firms could bear a disproportionate share of the cost increases, IEEFA's analysts said.
"The general E&P consensus for well cost inflation in 2022 appears to be anywhere from 5-15%, with many caveats across the board depending on the focus of the operator and the landscape of available service providers," Rystad Energy said in an analysis in November.
"Across the various operators, steel, labor and fuel were all flagged as areas of special concern in 2022 that would contribute the most to rising well costs," the energy research firm said.
However, many E&P companies have pointed to continued efficiency gains as potential offsets to rising costs.
"We continue to manage our costs, we think, very well in the Permian and across our portfolio. Our capital budget, which we announced in December, expected some COGS increase, modest in the low single digits. And what we might be seeing a little bit more than that in the Permian, it's very manageable and we think we can offset it with efficiencies," Chevron's CFO Pierre Breber said on the earnings call last week. During the call, CEO Mike Wirth noted that Chevron's production in the Permian would rise by around 10 percent this year compared to 2021.
Capex And Production Rising
ExxonMobil, for its part, grew its Permian production from 2020 to 2021 by over 25 percent, CEO Darren Woods said this week, adding that "Our expectation, as we go into 2022, is to grow another 25%."
Exxon's 2021 production in the Permian rose by nearly 100,000 oil-equivalent barrels per day to around 460,000 boepd.
It's not only Exxon and Chevron that plan higher production in their core assets in the U.S. shale patch.
Per Dallas Fed's survey, 44 percent of executives said they expect capital spending to increase slightly, while an additional 31 percent anticipate a significant increase in capex this year compared to 2021.
A total of 49 percent of 88 E&P firms polled in the survey in December pointed to "grow production" as their primary goal in 2022.
However, small firms—those producing less than 10,000 bpd—are more inclined to boost production, while this goal was cited as primary at only 24 percent of large E&P firms. The most-selected response among small firms was "grow production," while the most-selected response among large firms was "reduce debt," the survey showed.
Top Oilfield Service Providers Upbeat Despite Cost Pressures
Despite cost inflation, the largest oilfield service firms are optimistic that a multi-year upcycle in the industry has begun.
Halliburton, for example—the top provider of services in the U.S. shale patch—saw its completion and production division finish 2021 with a 15 percent operating margin, "driven by activity improvement despite inflationary pressures," chairman and CEO Jeff Miller said.
"I am excited about the accelerating multi-year upcycle. I expect the macro industry environment to remain supportive and the international and North America markets to continue their simultaneous growth," Miller said last month.
Inflation is more acute, and it's more pronounced in some parts of some basins, but it's a market condition and "something that we always deal with," Schlumberger's CEO Olivier Le Peuch said on the earnings call in January.
"Turning to 2022, more specifically, we expect an increase in capital spending of at least 20% in North America, impacting both the onshore and offshore markets, while internationally, capital spending is projected to increase in the low-to-mid teens, building momentum from a very strong exit in the second half of 2021," Le Peuch added.
While the shale patch is raising capital spending and production, it has to contend with rising costs, which, if not offset by efficiency gains, could eat into the 2022 profit margins of the producers that enjoyed record cash flows in 2021.
By Tsvetana Paraskova for Oilprice.com
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