The last barrel: U.S. industry adapts to new normal

Despite WTI surging to an 11-year high of $108.50/bbl in March, U.S. shale operators resisted ramping-up drilling activity and remained disciplined with capital expenditures. The speed at which new rigs have been deployed to the field is considerably less than in previous up-price cycles. Most U.S. shale companies are being conservative, as priorities remain focused on funneling record free cash from this year’s oil rally into share buybacks, dividends, debt reduction and acquisitions rather than drilling new wells. However, this new fiscal responsibility has been forced on the industry and is not voluntary. 

This point was hammered home at the American Association of Drilling Engineers Fluids Technical Conference and Exhibition in a keynote address on April 19 by Richard Spears, managing director of Spears & Associates. Spears’ talk, titled, How extreme financial discipline impacts drilling activity in 2022 and 2023, outlined what has caused oil companies to display uncharacteristic financial restraint, despite surging oil prices. 

No more boom/bust cycles. Spears outlined the familiar boom-and-bust cycle saying, “for decades, the relationship between oil price and U.S. land drilling activity was correlated and predictable, because with high oil prices, capital and debt surged into the industry to pursue reserve growth and production growth. However, in 2019, that came to a screeching halt, as a new generation of investors demanded their money back in the form of dividends and debt reduction. Every old relationship between oil price and rig count was thrown out the window, never to return.” Other factors include high company debt and the tainting and subsequent defunding of our industry initiated by the ESG movement. Also, there is hyper-inflation caused by rig/tool shortages created by underinvestment by the OFS sector. 

Opportunity for DUC reduction. For many operators, this environment is a perfect opportunity to draw down their DUC inventories, which has helped reduce capital expenditures while maintaining production levels. And according to the March 2022 tally by EIA, the DUC total stood at 4,273, a reduction of 2,639 wells on a y-o-y basis. In the Permian basin, operators have completed 1,854 DUC wells during the last 12 months, a reduction of 59%. The Permian count now stands at just 1,309 wells waiting on completion. It’s the 20th straight month of declines in the West Texas/New Mexico field, leaving the lowest inventory of DUCs in the largest U.S. oil field since February 2017. Six of the seven basins counted in the EIA report show reductions, with the exception of the Haynesville, where the DUC total stands at 383, an 18% increase on a y-o-y basis. 

U.S. shale production expected to grow. In spite of the lack of investor funding and free-flowing bank loans, crude production in the U.S. has recovered considerably from the lows seen during the first wave of the Covid-19 pandemic, and the brief price war between Saudi Arabia and Russia (GlobalData). The U.S. produced approximately 11.5 MMbopd in February 2022, a 19% gain over the May 2020 production of 9.7 MMbopd. 

“As most countries have eased Covid restrictions, global oil demand is anticipated to rise over the coming months. In line with this demand growth, the U.S. shale oil production is expected to increase further and could potentially reach pre-pandemic levels by 2023,” says GlobalData Analyst Ravindra Puranik. The EIA predicts WTI futures to average $113/bbl in May, and possibly remain in this range, depending on the duration of the Russia-Ukraine military conflict. “Oil prices were on an upward trend before the start of the Russia-Ukraine war, as global demand was projected to outweigh supply in 2022. Since then, several majors, including BP, Shell and ExxonMobil, have decided to exit from the Russian oil and gas industry amid concerns over Western sanctions. Some of these companies may divert their capital—which was earlier allocated for Russian assets—to the U.S. shale fields, as the prevailing high prices make shale drilling highly profitable,” Puranik concluded. 

U.S. natural gas prices skyrocket. The Russia-Ukraine war also helped drive natural gas prices at Henry Hub to a 13-year high during the first half of April, topping $6.7/MMBtu. Colder-than-normal temperatures in the northern U.S. and Canada were also a factor. The elevated domestic and export demand from Europe has brought U.S. storage to a lower-than-average level at this time of the year, helping to sustain higher prices (Rystad). While Europe has banned the import of Russian coal, and a few countries have banned Russian oil, gas flows from Russia to Europe increased 20% in March, compared to February. This suggests it will be some time before Russian gas exports are targeted, which may create a temporary sense of confidence in the market. However, with the rubles payment deadline looming, and the anticipated escalation of the situation in Ukraine, any relief for gas markets may be temporary. 

Change is painful. The U.S. oil industry has a long and proud history of suppling crude markets, and now we also export natural gas. The energy crisis triggered by Russia’s invasion of Ukraine has created a new demand that will drive billions of dollars of investment in the global oil and gas industry. The U.S. and European countries are planning new LNG terminals that will be in service for decades and U.S. suppliers will be pressed to fill a supply gap for nations moving away from Russian gas. And despite opportunistic statements about greens potential, consumption and demand are returning to pre-Covid event levels. Until proven otherwise, hydrocarbons still drive our economy and are delivering the reliable, cost-effective energy we require to get us through another difficult situation and beyond. Maybe the green guys could stop kicking our industry (at least momentarily), and just say “thank you.”  

About the Authors

Craig Fleming

World Oil

Craig Fleming Craig.Fleming@WorldOil.com