Some observers have been surprised by the stubbornly slow response of US shale production to WTI’s ascent towards $80/bbl.
Sector consolidation, 2021 hedging losses and an ongoing imperative to show financial discipline have been widely noted before. But now supply-chain bottlenecks and cost inflation are also afflicting the shale sector, just as they are the broader economy.
Former President Trump’s prediction of US “energy dominance” looked like hubris at the time, all the more so following April 2020’s price collapse and the subsequent muted rebound in US upstream activity as WTI has recovered towards $80/bbl.
The Biden Administration’s so-far unsuccessful appeals for Opec+ to accelerate production increases seemingly contradict a parallel raft of climate change policies that could ultimately restrict broader hydrocarbon investment. However, first things first, and with the inflationary and political implications of looming $4 per gallon gasoline, the Administration now faces calls to variously enact an SPR release, ban crude or refined products exports, relax restrictions on Federal Lands leasing or accelerate new pipeline approvals.
Nor is a mini-renaissance in US upstream activity out of the question, even though it is unlikely to bear fruit before high fuel prices dampen seasonal spirits for the upcoming holidays. Total active oil rigs in the US had reached 454 by mid-November, their highest since April 2020. A 50% depletion of the stock of drilled-but-uncompleted wells (or DUCs) since mid-2020 suggests a further uptick in drilling if steep legacy well decline is to be offset.
In contrast to the restraint shown by their independent producer peers, the likes of Chevron, ExxonMobil, BP and ConocoPhillips all look set to modestly raise upstream investment in the months ahead. Even for the more reticent independents, their lending bases – for borrowing linked to the value of reserves - are up sharply since prior valuations were made back in the spring. The US Energy Information Administration now expects Permian Basin production to regain record pre-pandemic levels above 4.9 mb/d by December. Forecasters more broadly (and including Argus Consulting) now expect between 500 and 700 kb/d of US crude output growth in calendar 2022.
However, financial rectitude will also persist. Among oil executives interviewed for the Federal Reserve Bank of Dallas Survey at end-September, one suggested that fully two years of deleveraging balance sheets and returning cash to investors might be required to attract new investment back into the E&P space. Third quarter earnings reports generally reflected similar caution, with Diamondback, Devon Energy, Pioneer and Continental, among others, announcing increased pay-outs for shareholders, alongside fairly cautious future production guidance. As the IEA noted in its November Oil Market Report, and I quote, “For now the US shale patch is more focused on returning cash than returning rigs”. In addition, sharp crude price increases in 2021 have also led to losses for some producers who heavily hedged their production for this year.
The Dallas Fed Survey also demonstrated that the US shale sector is now feeling the impact of labour and supply-chain bottlenecks of the sort that have afflicted the broader global economy for much of 2021. Not only do Covid-19 infections continue to disrupt upstream oil and gas operations, but 51% of oil sector respondents are facing difficulties hiring workers. Across industrial sectors nearly 65% of respondents saw persistent supply chain disruptions which could take six months or more to resolve, with 51% saying that such disruptions are worsening.
Halliburton and other service companies suggest that raw materials shortages, which have been a key impediment in 2021, could potentially ease in 2022. However, an adequate supply of qualified labour is seen remaining a constraint into next year. And equipment shortages after years of under-investment may leave the sector short of serviceable rigs, fracking and completion equipment. All of this is bidding production costs higher, suggesting more muted rates of profitability at $80/bbl than would have been the case even six months ago.
Of course, the inflationary sword can ultimately cut both ways: elevated inflation looks increasingly likely to accelerate monetary policy tightening by the US Federal Reserve in 2022. Expectations of inflation are themselves likely to boost the attractiveness of broader commodity investment compared to other asset classes. Investors may see less imperative to claw back cash from US shale producers if equities and other assets take a hit from rising inflation and higher interest rates. However, such a shift in investor priorities likely lies over the horizon, leaving the supply chain squeeze as one further short-term drag on US production volumes.
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