The Biggest Year Yet For U.S. Shale
U.S. shale companies are expected to ramp up production this year, and higher oil prices could lead to the industry turning profits for the first time.
For years, the shale promise has been hollow. Even when oil prices were trading above $100 per barrel, most shale drillers weren’t profitable. They drilled rapidly, brought huge volumes of production online in short order, and upended the global oil market. Any cash they recouped they ploughed back into the ground. The debt taken on to drill new wells was made on the assumption that future growth would translate into bigger earnings, and like any industry growing quickly, Wall Street was quick to pour money into evermore drilling.
But spending has vastly outpaced earnings. According to The Wall Street Journal, the shale industry has spent $265 billion more than it has generated since 2010.
The collapse of oil prices forced a deep contraction, with lots of write-downs, defaults, layoffs and bankruptcies. There was a period of time when Wall Street was lured back in on the promise of lower breakeven costs and substantial efficiency gains.
But profits still proved to be elusive. Only last year did major investors start demanding big changes. That led to shale executives committing to a more prudent and investor-centered strategy, which called for more conservative drilling programs and an emphasis on cash and profits over growth.
With oil prices suddenly and unexpectedly higher compared to just a few months ago, the shale industry could quite possibly have its cake and eat it too. The WSJ notes that the industry has all the ingredients it needs for 2018 to be a profitable one, a first for the industry. That could occur simultaneously with enormous volumes of fresh supply.
Shale drillers have lower breakeven prices, and so far they appear poised to keep spending in check. An analysis by Jeffries finds that a group of 20 small shale companies are planning on increasing spending this year by a modest 8 percent, a sign of restraint after hiking spending by 55 percent last year.
Meanwhile, oil prices are sharply higher right now than they were last year, granting an unexpected windfall to the industry. On top of that, a lot of drillers are sitting on drilled but uncompleted wells (DUCs), which basically means that some of the costs have already been accounted for. If some of those wells are completed this year, it will lead to a rush of new supply without a huge spending increase. The DUC list nearly hit 7,500 in December, up more than 30 percent from the start of 2017.
It isn’t all smooth sailing, however, particularly if “explosive” shale growth undercuts prices. But 2018 is shaping up to be the brightest year yet for U.S. shale. “There is always a risk that they will shoot themselves in the foot again,” John Castellano, managing director in the energy practice of consulting firm AlixPartners, told the WSJ. But, unlike in the past, this time around “the companies have much lower costs, better balance sheets, better management teams and more room to move.”
The EIA expects the U.S. to top 10 million barrels per day (mb/d) for the first time ever next month, with production averaging 10.3 mb/d for 2018. Output will then surge above 11 mb/d by the end of 2019, the agency predicts.
From there, things could get tricky. Argus Media reports that the Permian — where much of the shale growth will be concentrated — could face pipeline bottlenecks at some point in late 2019 or 2020. While there is ample room right now, producers are “going to run into another wall for infrastructure capacity,” Robert Barnes, the head of commercial crude for Magellan, said at the Argus Americas Crude Summit in Houston. That sentiment was echoed by Brent Secrest of Enterprise Product Partners, who said that at some point, there is “going to be a day of reckoning.”
But for the next few quarters at least, shale companies could enjoy some of their best numbers ever. And because share prices performed so poorly last year, and still lag the broader increase in crude prices, analysts see huge potential for energy stocks.
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