Could this be the last great American oil boom?
Recently, ExxonMobil, (NYSE:XOM) and Chevron, (NYSE:CVX) announced their intention to sharply increase production in their shale production by about 25% this year. The companies both already have a large production base, with XOM having added around 85,000 BOEPDs to their total of 460,000 BOEPDs in 2021. CVX is a bit behind XOM with around 300,000 BOEPDs, and expects similar growth of around 25 % in 2022. If this comes to fruition, it will add another 180-200K BOEPD to the increase in shale production in the United States that the Energy Information Agency-EIA projects will increase by about 800K BOEPD this year .
As I explained in a recent Item Oil Price this is due to fundamentally strong prices and a finite limit on the number of drilled but uncompleted-DUC wells that can come online. In this article, I quoted a Article Rystad who speculated that Level I drill locations had been advanced due to low prices at the time. This could portend an unexpected outcome over the next couple of years.
“Five months into 2020 and three months into the resulting downturn and collapse in drilling activity, we are seeing operators increasingly focusing on sweet spots. This should result in Tier 1 acreage accounting for a record 47% share of total drilling activity this year, compared to 36% to 40% between 2016 and 2019.”
So far, the biggest independents like Occidental Petroleum, (NYSE:OXY) and Pioneer Natural Resources, (NYSE:PXD), and others have not announced major revisions to their investment plans. These plans, called “maintenance capex,” had been formulated to maintain current production or increase it slightly to help stabilize oil prices at current levels north of $80 a barrel. However, the CEOs of two major production companies, ConocoPhillips (NYSE:COP), and OXY were quoted in a Reuters story acknowledging that shale production will rise significantly above previous projections from a year ago. Given this, it is likely that we will hear about upward revisions to previously announced capital budgets for 2022.
In this article, we’ll look at some near-term scenarios that will likely arise from this shift in strategy. Among them will be America’s last great oil boom..
Capital always seeks its highest return. This is an almost undisputed maxim of economics. Shale production, with breakeven costs in the upper $20s for large producers, has reached a point where production needs to increase, in part because of the margins offered by current WTI prices. It would be remiss of oil company executives not to allocate more capex to pump more from the ground in this scenario.
This will increase land rig utilization and significantly higher rig margins as operators seek to increase production. Let’s start with the overall number of EIA projects at around 800,000 BOEPDs by next year, which would bring US production back towards the BOEPD of around 13mm seen at the end of 2019. The EIA report on drilling productivity-DPR from the January 18and score a weighted average of ~1135 BEPPD of new oil per platform. Simple calculations suggest that if this goal is achieved, it will require the support of about 700 additional platforms to achieve it. For reference, over the past two years we’ve added about 400 platforms, up from the mid-2020 bottom of 253. (Gray line on the graph below).
PrimaryVision Data, Chart by Author
One of the takeaways from the chart is the relatively flat upward trajectory of US rigs over the past two years. It is particularly notable in the six months leading up to it, as the other key metric – oil prices, showed a strong inflection – 30% higher. This speaks to the capital restriction that shale producers have held tightly to. Until now.
Can we really see a doubling of the number of platforms over the next year? The incentives are certainly there, as we noted. But supply chain and personnel limitations can have an impact. All companies surveyed noted that despite renewed optimism about the future, supply chain-induced pricing pressures, logistical limitations due to trucking shortages, and the ability to find and train new employees. Halliburton CEO Jeff Miller commented in detail on how they were handling these challenges during their quarterly Q-4, 2021 conference call –
“As activity picks up, the market is experiencing stress related to trucking, labor, sand and other inputs. While we pass these increased costs on to operators, Halliburton offers effective solutions that minimize the operational impact of this sealing and deliver reliable execution to our customers. For example, in 2021 we expanded our collaboration with Vorto and now benefit from 5F, the oil and gas industry’s largest integrated transportation platform. This platform has several thousand drivers, hundreds of transporters and a chain of asset maintenance yards. This allows us to effectively manage trucking inflation and availability constraints and significantly reduce logistics-related non-productive time. Our human resources team and systems effectively alleviate local labor shortages. We recruit nationally and hire, train and manage a commuter workforce that represents up to 80% of our staff in some regions.
We’ve seen similar comments in reviews from other service and supply companies. One thing we haven’t discussed yet for the sake of brevity is the rate of decline of shale. I talked about it in detail in a Item Oil Price in December. You can read this for more information on shale decline rates that could impact drilling.
In summary for this section, the incentive for producers to sharply increase production incentivizes them to increase investment budgets to take advantage of it. If all of this goes as planned, the result will be a sharp increase in drilling activity in the shale plays. The logistics and supply chain issues plaguing the industry in general and, of course, the naturally high rate of decline in shale production offset this factor.
Lack of Tier I slots, second-order effects-
Other voices now echo the concerns I noted about the remaining quality of drillable inventory. An article published in the Wall Street Journal-WSJ, discussed this dwindling inventory of prime locations in a recent post.
“The limited inventory suggests that the era in which U.S. shale companies could quickly flood the world with oil is receding and that market power is shifting to other producers, many of them overseas. Some investors and executives in the energy sector said concerns over inventories likely prompted a recent round of acquisitions and would lead to further consolidation.
If, in fact, this reduced level of premium drilling locations is impacting shale production, then the burst of activity that I anticipate will not produce the desired and anticipated production growth results. Does this mean that the increase in drilling activity that I expect will also decrease?
Probably not. The rate of shale decline, aging well inventory, both suggest that a new drilling push needed to maintain or attempt to increase shale production to higher levels will eventually miss its target. .
Your takeaway meals
We believe that the production increases we are currently seeing are not sustainable. Companies can move to lower tier drilling sites that could not compete for capital in a lower price environment to avoid being locked out in a downturn. In any event, as these prime locations are used, production will drop.
This is bullish for long-term oil prices, as shale is expected to be an unlimited resource that has direct cause and effect for higher drilling levels. As we discussed, this is likely a misguided notion and fewer future barrels will meet increased demand, driving prices higher.
All of this is bullish for companies that drill and produce oil and gas, and as cash flow and margins improve with higher realizations, their share price multiples will also increase.
Investors entering the market now will have the chance to participate in an era of significantly higher oil activity. The old oilfield prayer, “just give me one more boom”, is about to come true.
By David Messler for Oilprice.com
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