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Oil Prices Could Be Set For Another Sharp Rise

Oil Prices Could Be Set For Another Sharp Rise

Bullish and bearish catalysts are…

Alex Kimani

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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Chronic Underinvestment Could Push Oil Prices Higher In 2022

  • After the fracking revolution left the U.S. shale patch bleeding cash and deeply indebted. Wall Street ramped up pressure on companies to cut debt and boost shareholder value.
  • The U.S. shale industry has exercised incredible restraint during this year’s oil price rally.
  • Consequently, investment in new wells has crashed 60% since its peak in 2014, which could send oil prices higher in 2022.

Long-suffering Americans grappling with runaway inflation are finally enjoying some reprieve. After a relentless climb, prices at the pump have been heading south, with national average gas prices tumbling to a 10-week low of $3.28 a gallon, according to AAA. Fuel prices started leveling out after President Joe Biden announced on November 23 the biggest-ever release from the Strategic Petroleum Reserve, though experts have dismissed it as a mere band-aid.  Whereas many people have placed the blame for high gas prices on the Biden administration, the real culprit has more to do with Wall Street than Pennsylvania Avenue.

The genesis of today's high gas prices can be traced back to financial pressure on oil companies from a decade of devastating losses and poor shareholder returns that have forced them to dramatically alter their business models. For years, Wall Street has pressured oil and gas companies to cut capex, and shift their cash to financial goals like boosting dividends and buybacks, paying down debt, as well as decarbonization, after the fracking revolution left the U.S. shale patch bleeding cash and deeply indebted.

Consequently, investment in new wells has crashed 60% since its peak in 2014, causing U.S. crude oil production to plummet by more than 3 million barrels a day, or nearly 25%, just as the Covid virus hit, and then failed to recover with the economy. 

No drilling

With Wall Street breathing down its neck, U.S. shale is literally running on empty: according to the U.S. Energy Information Administration's latest Drilling Productivity Report, the United States had 5,957 drilled but uncompleted wells (DUCs) in July 2021, the lowest for any month since November 2017 from nearly 8,900 at its 2019 peak. At this rate, shale producers will have to sharply ramp up the drilling of new wells just to maintain the current production clip.

The EIA says the sharp decline in DUCs in most major U.S. onshore oil-producing regions reflects more well completions and, at the same time, less new well drilling activity--proof that shale producers have been sticking to their pledge to drill less. Whereas the higher completion rate of more wells has been increasing oil production, especially in the Permian region, the completions have sharply lowered DUC inventories, which could sharply limit oil production growth in the United States in the coming months.

The two main stages in bringing a horizontally drilled, hydraulically fractured well online are drilling and completion. The drilling phase involves dispatching a drilling rig and crew, who then drill one or more wells on a pad site. The next phase, well completion, is typically performed by a separate crew and involves casing, cementing, perforating, and hydraulically fracturing the well for production. In general, the time between the drilling and completion stages is several months, leading to a significant inventory of DUCs that producers can maintain as working inventory to manage oil production.

According to S&P Capital IQ data, 27 major oil makers tripled capital spending between 2004 and 2014 to $294 billion and then cut it to $111 billion by last year. Once old wells were capped, new ones haven't been available to fill the production gap quickly. The question is how long the restraint by publicly traded oil companies will last. Capital spending is expected to clock in around $135 billion next year, good for a 21.6% Y/Y jump but still less than half 2014's level.

Shareholder returns

Other than severely limiting new drilling activity, U.S. shale has also been keeping its pledge to return more cash to shareholders in the form of dividends and share buybacks.

A recent report by progressive advocacy group Accountable.us says that 16 of 24 large U.S. energy companies have raised their dividends this year, while 11 made special dividend payouts totaling more than $36.5 billion. That's a pretty impressive payout ratio considering that the sector has so far reported $174 billion in profits this year. Indeed, "variable dividends" that allow companies to hike dividends when times are good and to lower them when the going gets tough has become a favorite tool for oil and gas companies.

Related: U.S. Gasoline Prices Haven’t Peaked Just Yet

Meanwhile, oil and gas companies have spent a more modest $8 billion in share buybacks, though ExxonMobil ((NYSE:XOM)and Chevron (NYSE:CVX) have pledged to buy back as much as $20 billion of stock in the next two years. The energy sector has made robust share gains in the current year, which could explain the reluctance to spend too much on share repurchases.

The most important reason, however, why oil prices are likely to remain high in the coming year is OPEC discipline:

"You have a cartel that is traditionally as disciplined as Charlie Sheen's drinking, and for the last year, they've been as disciplined as Olympic gymnasts," Tom Kloza, president of Oil Price Information Service, has hilariously told CNBC.

Oil shortage

According to the IEA, crude consumption is expected to improve to 99.53 million barrels per day (bpd), up from 96.2 million bpd this year, leaving it just a hair short of 2019's daily consumption of 99.55 million barrels. That will, of course, depend on the world bringing the new Omicron variant of Covid-19 quickly under control.

Higher oil demand will put pressure on both OPEC and the U.S. shale industry to meet demand. But let's not forget that numerous OPEC nations have already been struggling to add to output, while the U.S. shale industry has to deal with investor demands to hold the line on spending. So far, the U.S. shale industry has not responded to higher oil prices as they had done previously, with overall U.S. production averaged 11.2 million bpd in 2021 compared with a record of nearly 13 million bpd in late 2019. U.S. production is expected to only increase by 700,000 b/d in 2022 to 11.9 b/d, according to Rystad Energy's senior vice-president of analysis, Claudio Galimberti. 

Canada, Norway, Guyana, and Brazil could try to bridge the supply-demand gap, but several Wall Street punters are betting it will not be enough and oil prices will remain elevated.

In fact, Barclays has predicted that the WTI contract price will increase from the current rate of $73 to an average price of $77 in 2022, noting that the Biden administration's sale of oil from the Strategic Petroleum Reserve isn't a sustainable way to bring down prices. Barclays says prices could go even higher than that forecast if COVID-19 outbreaks are minimized and thus allow demand to grow more than expected. 

Goldman Sachs shares that bullish outlook and has predicted a Brent price of $85 per barrel by 2023 compared to the current $76.30.

By Alex Kimani for Oilprice.com

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Leave a comment
  • Suqi Madiqi on December 30 2021 said:
    Why would a oil company spend billions on infrastructure to see returns in 4 to 6 years if "environmentalists" are doing everything in their power to destroy the very investment? The enviro's are not the friends of the working class.
  • Carlos Everett on December 30 2021 said:
    Every time this topic comes up, certain issues are left out , which could substantially drive prices one way over the other.

    So lets talk about the BIden Administration policies that have been left out of your article

    -First Keystone PL was cancelled which would have allowed another 1.0 million b/d to flow into the U.S. from Canada, who is an ally keeping gasoline prices down. Again for emphasis, Canada is an ally.

    -Second, for the first 8 months producers were not allowed to lease land on Federal properties, thus keeping some of the prime property off of the market, where producers could have drilled.

    -Third, Biden allows Russia to complete a new natural gas pipeline, which allows Russia to basically manipulate natural gas prices in Europe by pumping natural gas either way. So , instead of putting America first and trying to get Europe to enter into long term natural gas contracts with US in particular, or other countries, which would keep the Europe market much more stabilized..

    Just to emphasize the point, Biden cancels a large diameter pipeline coming into the US or Keystone PL, yet our number one reason why we are investing hundreds of millions dollars into NATO to keep Russia from starting WWIII, Biden allows Russia to finalize and construct a large diameter pipeline into Europe, for thos who forgot Russia is not an ally. Now it does not take a person with much IQ to ask the simple question, if you allow a cold war enemy to build a supply pipeline, why would you not allow the US. to finish a large diameter pipeline. Everyone in America is still waiting for BIden to respond to this question, yet Biden and his advisers, now understand how idiotic this policy was that they have egg on their face as it does not make sense.

    Now, if you do not understand how the Biden administration policies, which are the opposite of what the republicans were doing which had resulted in placing America first, with the domestic industry setting production records and keeping a lid on prices for not only Americans but Europe also, then, you need to go back to Energy 101 class and enroll again as a freshman, which would be for obvious reasons.
  • Mamdouh Salameh on December 30 2021 said:
    The robustness of both the global economy and the global oil demand means that we could expect crude oil prices in 2022 to recoup all their recent losses and resume their surge which could take Brent crude beyond $85 a barrel during the first quarter of 2022.

    However, a widening deficit in the global oil market resulting from underinvestment in oil and gas during the last two years could lead to $100 oil by the end of 2022 or the first quarter of 2023.

    Global oil demand in 2021 reached 99 million barrels a day (mbd) and is projected to rise above the 2019 level of 101 mbd in 2022. Global demand will be further incentivized by the fact that a global return to lockdown is very unlikely after the latest medical reports on Omicron variant showed that its symptoms are very mild and that the number of deaths caused by it are very few.

    OPEC+ as the most influential player in the global oil market will continue to monitor the market. If it felt that the market is headed towards a deficit, it will implement the production increases it has already agreed upon. If, however, it felt the market is over-supplied, it will definitely freeze any production increases.

    Shale oil production will never make a comeback to the reckless production level in 2019. Despite rising crude oil prices, shale drillers are under obligation to return more cash to shareholders in the form of dividends and share buybacks. Moreover, they are only able to raise their production by 200,000-300,000 b/d in 2022.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Lee James on December 31 2021 said:
    American domestic producers are under no obligation to increase production in 2022. The lower production of today is for good reason. The sale of a barrel of crude, when there is good demand for that barrel, is worthwhile if production cost aligns well with sale price.

    I do not see that US petroleum is in a position to suddenly increase production (absent another frothy stable of investors). I think I'm still seeing high production cost in shale formations and deep-water.

    Where oh where did the bonanza-reservoir pockets of oil go? Well, that oil was the first to go. I think we have to consider just how gone it is, and what alternatives we have when oil production turns "tough."

    We can hope that such developments as the cleaner pulse stimulation technology (reported by Robert Rapier in Oilprice recently) can turn the tide.

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