Can Market Rely on New Shale Sector?

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What is the capacity for growth in shale's new era? While US shale producers’ recent capital discipline does not mean no growth, it does mean significantly less growth as firms prioritize free cash flow more than in prior cycles. But if oil prices continue to rise and Opec-plus spare capacity whittles away over the next year or so, there could be a real need for new supply. Shale would have been quick to answer that call in the past, but this time its response will be tested by investor demands for financial returns. That makes shale a huge wild card in the post-pandemic oil market. Expectations for a rapid recovery in global oil demand helped push West Texas Intermediate (WTI) crude past $70 per barrel recently to a 2½-year high. But most shale producers have not jacked up capital spending and drilling activity much, even though their break-even costs are now around $30-$40/bbl, down from around $51/bbl at the start of 2020, according to Morgan Stanley. Privately owned producers, not bound by investor focus on free cash flow, have largely driven the increase in the US oil rig count from 172 at the trough of the pandemic in August 2020 to around 365 today (PIW May21'21). To get back into investors’ good graces, publicly traded shale producers are directing much more cash flow to debt reduction, dividends and buybacks than they did in the past. In the first quarter, 39 public producers reinvested just 57%, or $8.9 billion, of the $15.5 billion in cash flow they generated, according to data compiled by RBN Energy. That’s down substantially from the 84% reinvestment rate seen in 2020 and a far cry from the business model they used in the years before the pandemic which saw shale producers wildly outspend cash flow by tapping debt markets (PIW Feb.26'21). The big question is whether and how shale’s grand bargain with investors could change once oil markets demand more supply as the world continues to recover from the pandemic. Among non-Opec producers, shale holds an important place as a short-cycle "swing" supplier that can increase or decrease output volumes relatively quickly based on market signals. The freewheeling, debt-fueled boom years won’t return, but shale can still satisfy investor demands and grow. Prices will go far in determining shale's future reinvestment and production growth rates. Many shale producers have committed to holding volumes flat as long as the oil market is artificially supported by Opec-plus supply cuts, but market dynamics may change as Opec-plus brings more production back and its spare capacity wanes (PIW Jun.11'21). At WTI prices of $50/bbl, Morgan Stanley sees shale growth of 350,000 barrels per day from end-2021 to end-2022, a rate that increases to 580,000 b/d under $60 WTI and 750,000 b/d under $70 WTI. US oil production has rebounded to around 11 million b/d after falling to around 10 million b/d in May 2020, according to the US Energy Information Administration (EIA). With WTI above $60/bbl, EIA expects 2022 production will average 11.8 million b/d, up from a forecast average of 11.1 million b/d in 2021, and will exit 2022 at around 12 million b/d. Energy Intelligence does not see US oil production surpassing its pre-pandemic record high of 13 million b/d and expects more moderate shale growth over the next 18 months compared to the EIA and the International Energy Agency (IEA). Energy transition pressures, including demands to cut emissions, and stagnant oil demand in North America in the coming years will work against shale, as will falling US refining capacity and a more competitive market for US crude exports. Biden administration climate policies could also work against shale in future years (PIW Jun.4'21). Energy Intelligence forecasts US crude production to increase by 550,000 b/d in 2022, compared to the EIA’s 700,000 b/d forecast and the IEA’s 900,000 b/d prediction. Energy Intelligence thinks US crude output will approach 12 million b/d by end-2022 and will add 250,000 b/d of natural gas liquids output next year, which would also eat into Opec's need to meet rising demand.

Shale, Opec-Plus Supply , Opec/Opec-Plus
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