US Shale Production Growing — Cautiously

Copyright © 2021 Energy Intelligence Group

US oil is staring down its highest price in seven years. But don’t expect $80 per barrel crude to spur a return to maximum growth. Production will most certainly rise next year, as major producers move beyond this year’s “maintenance” budgets, set when crude was half its current price. However, the top-heavy, still-consolidating shale sector still has capital discipline in its sights — and companies won’t quite be able to get the same bang for their capex buck. Energy Intelligence forecasts the 2022 gain in US crude output at around 600,000 barrels per day on a year-average basis, a considerable volume but less than the 1 million b/d rise these price levels would have been expected to bring in the shale boom years.

Energy Intelligence’s Oil Markets Service expects US crude output to average 11.1 million b/d this year. That marks its lowest annual average since 2018, but is a healthy clip above the 9.7 million b/d lows touched in May 2020 during the height of the pandemic-led price collapse. The focus this year has been on stabilizing output, and production has indeed been on an even keel outside of disruptions related to storms around the Gulf of Mexico.

Growth lies ahead. Assuming US benchmark West Texas Intermediate (WTI) averages $75/bbl next year, Energy Intelligence figures output will exit 2021 at 11.3 million b/d — roughly flat with current levels — and end 2022 at around 12 million b/d. That would peg full-year 2022 output at 11.7 million b/d, well below pre-pandemic heights near 13 million b/d.

First and foremost, “$80 oil” is a bit of a misnomer. The US crude futures curve is in steep backwardation, with volumes slated for December 2022 delivery trading below $74, which is more than $8.80/bbl cheaper than their January 2022 counterpart. What's more, producers set budgets against more conservative pricing than futures. Analysts reckon US exploration and production companies are more likely to set 2022 budgets against $60-$65/bbl WTI — far above the $40 benchmark used by most for 2021, but still allowing some room for prices to fall.

Although some have begun arguing that $100 oil could soon return, the coronavirus pandemic is still weighing on global travel, and others worry that wider inflationary pressures could ease economic activity next year, potentially causing oil prices to cool.

Capital discipline is also firmly in place. Often misunderstood as equating to “no growth,” capital discipline instead dictates that growth should be dictated by returns rather than the prevailing oil price, that capex should remain well within cash flows, and that returns to shareholders should be robustly funded. Those demands from investors aren’t going away.

This year was always expected to be a trough in capital spending, barring an extended, extreme downturn in oil prices. Major US E&Ps reinvested less than 50% of their operating cash flows in the first half of 2021, Energy Intelligence analysis found, and that figure will fall as the year progresses, given higher cash flows from rising oil and gas prices. Analysts at Wells Fargo figure the pre-dividend cash flows of E&Ps will have risen by 35% between the second and third quarters alone. Producers generally see reinvestment levels of 60%-70% as more sustainable longer term.

Keeping Capital Efficient

Another limiting factor is capital efficiency. US shale producers have logged record operational efficiency gains coming out of the depths of the pandemic. But the production netted per dollar invested will ease in the coming months as companies have fewer drilled but uncompleted wells (DUCs) to tap and cost inflation hits key goods and services.

Capturing the wider efficiency trend, Occidental Petroleum’s Vicki Hollub told the recent Energy Intelligence Forum that her New Mexico drilling team delivered a self-set $10/bbl break-even reduction target by improving efficiencies in every aspect of drilling, completions, artificial lift and subsurface work — a target she had thought was simply aspirational.

Going forward, however, inflation is likely to mitigate some savings. The Dallas Federal Reserve’s latest energy survey had a record number of oil-field services executives report quarterly increases in raw materials and labor costs — costs they will fight to pass onto their customers. Wells Fargo has a 10% inflation rate baked into its 2021 estimates, while David Heikkinen of PEP Insights figures it may push north of 20%.

Producers, meanwhile, are heavily depleting their inventories of top-tier DUCs this year to maximize their extremely tight budgets. That means these companies will have to put more rigs to work to add attractive barrels.

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