Shale discipline gears up for biggest test yet

The US shale sector's financial discipline of the past year is facing its biggest challenge yet, as persistently high crude prices boost profits while signs that the latest Covid-19 wave will pass quickly indicate improved demand growth prospects.

US crude output will reach an annual record of 12.4mn b/d as soon as next year, according to the EIA, despite pledges by shale producers to exercise capital restraint. And production in 2022 is expected to average 11.8mn b/d, up from 11.2mn b/d last year. The EIA cites oil prices that "we expect will be sufficient to lead to continued increases in upstream development activity, which we forecast will proceed at a pace that will more than offset decline rates".

EOG Resources chief executive Ezra Yacob recently raised eyebrows when he said the shale producer could boost output by the summer if market conditions — specifically, the combination of global inventory levels, demand and Opec+ spare capacity — line up to show the need for higher US crude output. "Then EOG would be in a position to return to pre-Covid levels of production, which would be about 465,000 b/d, no more than 5pc growth," Yacob told a Goldman Sachs conference earlier this month. "If the world has a call on oil and there's room to grow our low-cost, lower-emissions barrels into the market, we can certainly deliver on that," he said.

With the exception of privately held exploration firms, the shale patch has been on its best behaviour during the oil market's recovery from the pandemic-induced collapse of 2020, which briefly saw US crude prices turn negative for the first time. Publicly listed companies have been focused on paying down debt and ramping up investor returns — through dividends and buy-backs — rather than pursuing their former growth-at-all-costs strategy. But questions remain about how long the new industry mantra of capital discipline will last, as oil prices push higher, demand bounces back and doubts linger about the ability of Opec+ to restore supply to the market. "Could it erode?" asks Tom Jorden, chief executive of Houston-based Coterra Energy. "Of course it could. But I don't see signs of it in 2022."

The $100/bl question

Other shale executives speaking at the Goldman conference agreed that shareholder sentiment would need to change before the sector resumes growth. "Right now, for most of us, shareholders are saying we don't want you to grow, we're in love with returns," Diamondback Energy chief executive Travis Stice says.

But some producers could be tempted to open the taps if oil prices continue to rise. "I don't think it'd be good for the industry, but if oil was over $100/bl, then that probably does signal some growth," Stice says. His counterpart at Devon Energy, Rick Muncrief, plays down the threat posed by private equity-backed independents, which are relatively free of the shareholder pressures faced by their publicly listed rivals. "I don't know that the privates will truly move the needle," he says.

Production this year will be driven by the oil majors and privately held independents, Bank of America predicts. Higher spending will be concentrated on the Permian basin of Texas and New Mexico, which the bank's analysts expect to hit a new annual production record of 5.3mn b/d. Consultancy Rystad Energy forecasts that US shale capital expenditure (capex) will surge by 18pc to $84bn this year, up from $71bn last year. Almost a fifth of companies in a survey by the Federal Reserve Bank of Kansas City expect capex to increase significantly this year, with firms in US central Great Plains states needing crude prices to average $73/bl to trigger a substantial increase in drilling. But a survey last month by the Federal Reserve Bank of Dallas highlighted shale producer concerns that rising supply chain disruption and associated inflation could weigh on drilling and completion activity in 2022, constraining growth prospects, despite higher spending.

By Stephen Cunningham