A lot of news has been coming lately from the U.S. shale patch. Output in the Permian has broken records for two months in a row. The Energy Information Administration has forecast that the U.S. total could also break a record this year, thanks to higher prices.
But is this news good enough?
The rig count is on the rise; there is no question about it. Output is also on the rise. Yet, according to industry executives, this does not necessarily equate to a return to business as normal. On the contrary, it seems that most of the industry is determined to stick to its financial discipline and keep returning cash to shareholders instead of boosting production.
In an interview with the Financial Times, the chief executive of Devon Energy said that shareholders are, on the whole, still skeptical about production increases, and companies are heeding this sentiment.
“In the back of everyone’s minds is, ‘When is it going to be [production] growth? . . . We have investors saying ‘My gosh, if not now, when?’” Rick Muncrief told the Financial Times. “But for every one saying that, there’s at least one other if not two others waiting to say, ‘Gotcha! We knew that discipline would be shortlived.’ We have learned our lesson,” he added.
Investor sentiment is perhaps the biggest reason U.S. shale is still acting with restraint. After years of burning cash and issuing new stock to make ends meet, the shale industry is aware that shareholders have run out of patience. The oil price rally served an important purpose, then, in giving shale companies the means to start returning cash to their owners after the chaos of 2020.
That chaos, with tanking demand for oil amid the first wave of lockdowns and U.S. oil dropping below $0 per barrel for the first time in history, although briefly, seems to have given U.S. shale drillers the scare they needed to rearrange their priorities from “Growth at all costs” to “Returns above all”.
“The capital that historically we would spend in growing the company, now we’re redeploying that in the form of share repurchases,” the FT quoted Diamondback Energy’s chief executive as saying in January. It also noted Pioneer Resources’ CEO’s assurances that the company will only increase production by 5 percent this year.
At a time when investors are wondering if it is even worth it to stay in oil, what with the energy transition and ESG commitments, investor retention has become challenging, motivating companies to change their behavior.
Yet shareholder satisfaction is not the only reason U.S. shale is holding back on production expansion. After all, there are plenty of private oil drillers in the U.S. shale patch that do not answer to shareholders. These are the companies that analysts see as leading the total increase in U.S. oil production, perhaps precisely because they don’t answer to shareholders.
Meanwhile, however, drillers may be running out of sweet spots in the shale basins of the country. In an article citing well data, the Wall Street Journal reported earlier this month that because of the quick depletion rates of shale wells, low-cost resources are giving way to higher-cost deposits. And this is motivating a warier approach to production growth.
“You just can’t keep growing 15% to 20% a year,” Pioneer Natural Resources Scott Sheffield told the Wall Street Journal’s Colin Eaton. “You’ll drill up your inventories. Even the good companies.”
Devon Energy’s Muncrief has no intention of raising production at all this year, according to the FT article. Devon Energy will be maintaining current production levels only.
There is also a third reason for this restraint that has surprised many observers. Cost inflation has not passed the oil industry. It is boosting production costs now because it went through most of its drilled but uncompleted well inventory last year and will now need to spend more on new drilling.
With shareholders still suspicious of production growth as a strategy, it would be difficult to justify higher capital spending for boosting production when you need to spend more just to keep production flat on last year’s.
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To top it all off, persistent supply chain problems and labor shortages are adding to the challenges of living up to EIA’s forecasts of record production. According to the FT, industry sources say that while deploying a rig in the field might have taken a few weeks before, now it could take up to four months.
It is a most unfortunate convergence of factors. Prices of WTI above $90 per barrel would have normally made everyone rush to drill. But even if they wanted, drillers can’t rush to drill, at least not as fast—or as cheap—as they used to. But it seems that investor concern remains the top priority for public companies.
“We have to do what Wall Street wants . . . or else your stock craters,” Continental Resources’ Harold Hamm told the FT.
By Irina Slav for Oilprice.com
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Since the end of 2020 excuses have been coming thick and fast about the inability of shale oil drillers to raise their production significantly despite soaring crude oil prices.
The real reason is that all the sweet spots in the shale plays have been utilized and drillers are now moving to poorer and less productive spots. Because of the fast depletion rates of shale wells at 70%-90%, low-cost resources are giving way to higher-cost deposits. Another reason is a declining well productivity. Yet another reason could be capital expenditure discipline. Investors are interested in a good return on their investments rather than a reckless and unprofitable rise in production.
Yet, the failure of shale drillers to raise production significantly has less to do with capital discipline and far more to do with inability to do so.
Despite the above, the EIA has forecast that U.S. total oil production could break a record this year, thanks to higher prices whilst Rystad Energy claims that at $100 a barrel, shale oil production could rise by 2.2 million barrels a day (mbd) by 2023. If that is true, they could have done it when Brent crude hit $70 being higher than the breakeven price of shale oil at $45-$68 a barrel.
The maximum shale oil production could rise in 2022 is estimated at 200,000-300,000 barrels a day (b/d) above 2021 average of 11.0 mbd.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London