If there is “price war” in the oil market, as Adel Abdul Mahdi, Iraq’s oil minister, has suggested, the US shale industry is refusing to take flight at the first sound of gunfire.
Many shale companies are working on their 2015 capital spending budgets, to make announcements late this year or early next, and have said that they are reassessing their drilling programmes in the light of the fall in the oil price of more than 25 per cent since June. A few that had already set out spending plans have in the past couple of weeks announced cuts.
So far, though, they look like tactical withdrawals to concentrate their efforts where they will be most effective, rather than admissions of defeat.
Activity is already starting to slow. There were 1,568 rigs drilling for oil onshore in the US last week, 41 fewer than in mid-October, according to Baker Hughes, the oil services group.
That figure is likely to fall further over the coming months. Halcon Resources, which operates in the Eagle Ford shale of south Texas and the Bakken of North Dakota, said it planned to run just six rigs next year, compared with the eight it is running now and the 11 it had previously planned for 2015. Other leading shale oil companies have announced reductions in their capital spending plans: Continental Resources cut its 2015 budget from $5.2 billion to $4.6 billion; Rosetta Resources said it would spend about $950 million next year, down from $1.2 billion in 2014; and ConocoPhillips said it planned to spend less next year than the $16 billion it is spending this year.
Other companies have suggested they are likely to follow suit. EOG Resources, one of the most successful shale oil producers, said at the time of its third-quarter results that it planned to ensure that its capital spending plus its dividend payments were in line with the cash flow it has coming in, and that would probably mean reduced activity in some areas.
The pressure on shale producers is not so much profitability as liquidity. William Thomas, chief executive of EOG, said that even if oil fell to $40 the company could still earn a 10 per cent return in some areas, including the Bakken and the Eagle Ford shales.
Pearce Hammond, an analyst at Simmons & Co, says that rate of return calculation is less important than another critical question: “How much cash do you have going out the door to drill the wells, and how much do you have coming in?”
Debt has fuelled the shale boom, as producers outspent their cashflows and needed to borrow to fund investment. As prices fall, the companies that borrowed too much will find themselves under strain.
The bond markets have already started to reflect some nervousness, with yields on junk bonds in the energy sector rising to their highest level in more than a year. Sean Sexton, an energy specialist at Fitch, the rating agency, says that last year he was surprised by how investors’ enthusiasm for oil companies’ debt was such that even low-rated companies were able to borrow at rates below 6 per cent. Now that discrepancy appears to be being corrected.
Nevertheless, although oil prices at present levels of about $75-$80 for US crude will put pressure on some marginal companies, others should be fine, even if they still need to borrow to fund their drilling, Sexton says. “They may have to pay a bit more in interest costs, but it’s not like they’re not going to be able to go to the market and raise money.”
Pioneer Natural Resources, another shale oil producer, showed that the equity market was still open as a source of funds, announcing a planned share sale to raise $1 billion to help finance its investment plans.
While the debt and equity markets remain supportive, shale drilling activity is likely to ease off rather than collapse.
Although they may be drilling less than they had expected, oil companies will also be focusing on maximising the production from the rigs they are using.
John Richels, chief executive of Devon Energy, told analysts that the company expected to cut the number of rigs it had running in the Mississippian region of northern Oklahoma and southern Kansas, described as an “emerging” business, and to shift them to more productive areas.
Companies are also constantly pushing to use their rigs and other equipment more efficiently. Hess, one of the leaders in the Bakken shale, said in a rare presentation to analysts that it had cut the cost of each well there to $7.2 million in the third quarter, down from $9.5 million two years ago.
Chesapeake Energy, founded by shale entrepreneur Aubrey McClendon but under new management since last year, said that it had cut its capital spending by 60 per cent from $14.2 billion in 2012 to an expected $5.7 billion this year, but had still increased production from its continuing businesses by 12 per cent in the first nine months of 2014 compared to the equivalent period of 2013.
It is this sort of improvement that encourages shale producers to continue to project growth in output. Devon is talking about 20-25 per cent growth in its oil production next year, with capital spending about the same as this year, while EOG is projecting “double-digit” growth to 2017, if US crude stays at about $80. Continental is projecting growth of 23-29 per cent in its output next year, and Pioneer expects 16-20 per cent each year to 2016.
These growth rates are based on annual averages, and these companies have generally been growing rapidly during 2014, so the comparisons with production at the end of this year will be less impressive. It is worth remembering, too, that the companies’ predictions will not necessarily be fulfilled; it is important for them to show their investors they are still growing, so they have a temptation to err on the side of optimism.
Still, if the statements of the shale industry’s leaders are even broadly accurate, it looks as though oil prices will have to go significantly lower before US oil production starts to fall.
— Financial Times
