The consensus among publicly traded US shale producers was crystal clear coming out of the fourth-quarter earnings season. Returning capital to investors was the top priority, which meant holding the line on production growth and capital expenditures—thus showing that the sector had learned from previous overinvestment cycles. Just 2 weeks and a bumper crop of war-related headlines later, that agenda is being hotly debated in Washington, over the airwaves and online by people sprinkling their arguments with an “energy independence” here and an “unused leases” there.
It's likely that will be as far as things go, analysts say—at least until the tone from the White House changes in a major way. (A caveat on this fast-moving story: On Mar. 8, US President Joe Biden announced a ban on US imports of all Russian oil, ratcheting up sanctions for Russia’s invasion of Ukraine. It’s not clear what next steps that might produce from lawmakers or the administration.)
Along with pressure from investors to hold the line on capex, the combination of price uncertainty—it’s not at all clear where markets might settle following their spike since Russia launched its invasion of Ukraine Feb. 24—and rising labor and equipment costs make it a long shot that domestic shale producers will find themselves compelled to meaningfully boost production as Russian oil is sidelined from the global market. Subash Chandra at Benchmark Research told Oil & Gas Journal he has heard some investors talk about the need to make a strategic shift but hasn’t seen such sentiments come from prominent firms with lots of capital invested in the sector.
“They think the current approach is working. They don’t want to mess with it now,” Chandra said of plans by producers such as Devon Energy Inc. and Pioneer Natural Resources Inc. to send billions of dollars back to investors via fixed and variable dividends and share buybacks. “Everything these companies have done in the past 24 months on this front is what the large, long-only investors were asking for before that.”
Analysts at Cowen and Company LLC on Mar. 7 said they don’t expect many management teams to re-evaluate their spending plans. The math is simple, they pointed out: Even if oil retreats to $100/bbl, most of their companies will generate free cash flow yields of 20% or more.
It is possible, Chandra added, that the Biden administration changes its tone from standoffish—Press Secretary Jen Psaki on Mar. 4 pointed out that the industry “is literally sitting on stockpiled leases and permits,” a comment industry leaders have since called a red herring—to more conciliatory. Such a move could involve gathering a coalition to coordinate a notable production increase in exchange for some longer-term regulatory benefits to operators, Chandra said.
Pioneer Chief Executive Officer Scott Sheffield, who last month said the industry’s investment discipline coupled with supply and transportation constraints meant a big jump in output just isn’t going to happen in 2022, recently opened the door to being part of a Beltway-coordinated plan to ramp up output. But his overture and comments from some of his peers were met by Biden administration officials with variations on Psaki’s theme that companies are free to increase production if they want to.
Rystad Energy researchers have calculated that such a coordinated industry response could bring to market about 600,000 b/d of incremental oil and about 4.5 bcfd of incremental gas during the second half of this year. But such an initiative appears unlikely at this (admittedly early) point, which means the onus to make change falls on executives willing to buck consensus. And they do not (yet?) have political cover to go against Wall Street’s wishes.
“You’re going to have to make a big-boy decision without Big Government giving you an easy way out,” Chandra said.
To be clear, output by US drillers is set to grow this year: The Energy Information Agency is forecasting that production of crude oil and natural gas liquids will grow to 17.6 million b/d in 2022 from an estimated 16.5 million last year. ExxonMobil and Chevron have committed to sizable increases from their holdings in the Permian basin while Pioneer, Devon, and others have laid out plans to grow their production by about 5%. But decisions today to ramp up further wouldn’t begin to add barrels to the market until the fourth quarter.
In addition, executives inclined to make the call to boost production will face other constraining factors. The cost of labor and materials in the Permian and beyond is climbing rapidly—a number of companies reported recently they are budgeting for double-digit increases in labor spending in 2022—and deciding to ramp up investment will exacerbate that trend and cut into per-bbl profitability even prices stay above triple digits for a while. On top of that, Artem Abramov, head of shale research at Rystad, said incremental gas production is likely to run into logistical problems.
“Even in our original base case, we are getting to full utilization of all available LNG capacity and +0.5 billion [cu ft/day] of exports to Mexico,” Abramov wrote in an email. “This will both ruin the domestic gas market and result in new takeaway capacity challenges in the Permian as early as 4Q22.”
The global situation remains in flux and the debate about how the energy sector should respond is likely to continue to produce noise and maybe a public-relations headache or two. It’s a notable difference from the consensus of mid-February.
“Energy just can’t get an easy ride,” Chandra said. “We were turning the corner and setting up for a fantastic 2022 and now we’re in the middle of all these competing interests, policies and biases.”