After two years of belt tightening, shale drillers’ capital budgets are set to rise in 2022
Energize Weekly, December 29, 2021
The shale oil sector’s recent financial recipe of generating cash flow and tamping down capital expenditures may change in 2022 as drilling budgets increase due to factors ranging from inflation to higher oil prices.
Industry analysts forecast a sharp increase in drilling, and Rystad Energy projects capital budgets for the largest shale-focused companies rising almost 20 percent to $83 billion – the highest level since the COVID pandemic started in early 2020.
Even before the pandemic, shale operators had pulled back on drilling as they faced a backlash from shareholders and investors over their spending outrunning cash flow, leading to balance-sheet deficits across the industry.
“Companies that are showing capital discipline are the ones that have been rewarded by investors,” Clark Williams-Derry, an analyst with the Institute for Energy Economics and Financial Analysis (IEEFA), said in an interview.
“The turmoil in the last two years has taken place in the context of COVID, investors don’t know what is going to happen next week,” Williams-Derry said. “Capital discipline is taking place in the context of a tremendous uncertainty over demand.”
An IEEFA analysis of 28 North American shale-oriented companies found that they collectively spent $21.7 billion on well drilling, well completion and other capital expenses in the first three quarters of 2021 – 8 percent lower than the same period in 2020 and 43 percent lower than in pre-COVID 2019.
Rystad Energy did a third-quarter assessment of 21 publicly trade U.S. producers, who account for 40 percent of sector’s 2021 production, and found that the third-quarter rate of reinvestment was 46 percent, down from 53 percent for the same period in 2020, and well below the historical average of 130 percent.
The reinvestment rate was calculated by comparing shale producers’ oil and gas capital expenditures against their cash flow from operations.
The cash flow from operations for the last quarter was the strongest since the second quarter of 2019, Rystad said.
Some of that cash flow may now be directed back into drilling new wells and other capital projects for three reasons, IEEFA said.
First, the industry’s inventory of drilled but uncompleted wells (DUCs) has reached its lowest point since 2014, dropping from a peak of about 9,000 in early 2020 to fewer than 5,000 by mid-2021.
These previously drilled wells enabled companies to bring on new production more cheaply as drilling makes up 25 percent to 35 percent of the cost of a new well. DUCs accounted for 1,000 new wells in 2020 and 2,900 in 2021 – saving $10-billion drilling expenditures, according to the U.S. Energy Information Administration (EIA).
“There is only so low it can go; the industry must always keep some DUCs on hand to schedule their completions efficiently,” the IEEFA analysis said. “If fracking-focused companies want to maintain current levels of production, they may soon have little choice but to increase the pace of drilling.”
Inflation is the second force that could raise capital spending in 2022, as drilling costs – tracked by U.S. Bureau of Labor Statistics – are up 7 percent since January.
Together, the decline of available DUCs and inflation could boost 2022 capital expenditures by 10 percent, according to IEEFA.
Rystad Energy calculated that the year-on-year service price inflation by itself would add $9.2 million to capital costs, increased activity would account for another $8.6 billion. Those costs would be partially offset by $4.2 billion in efficiency gains.
A third trend that could add to the increase in capital costs next year is the gradual increase in well completions. In the first half of 2021, the industry was completing 772 wells a month, but from July to November, the pace increased to 868 wells a month, according to the EIA.
“As production gradually rebounds, the industry will face higher total costs for bringing new wells into production, further boosting capital spending,” the IEEFA said.
The increased pace of drilling has been spurred by a rebound in oil prices with the spot price of West Texas Intermediate (WTI) crude up 42 percent since the start of the year closing at $68.69 a barrel on Dec. 20. The price had been as high as $85 a barrel. In 2020, it averaged $39.16 a barrel.
The rising prices have lured some operators back into the field and placed pressure on others, Williams-Derry said.
“Investors are pretty happy with how the oil and gas industry is performing right now, it is producing cash, paying dividends and paying down debt,” he said. “Varying from that could hurt stock prices.”
At the same time, some companies – particularly privately held operators – are taking advantage of the higher prices to capture profits.
“Private equity, private money has been freer to drill more than their peers,” Williams-Derry said.
For example, the August 2021 production of Midland, Texas-based and privately held Endeavor Energy Resources was up 40 percent over August of 2020. By November, it had reportedly increased its Permian Basin rig count from three to five operations.
“The more you start seeing companies breaking ranks, squeezing a little more production, to make a little more revenue, the more pressure there will be,” Williams-Derry said.
In 2020, capex spending in the Permian and Haynesville plays was resilient. As a result, the two plays have seen a faster structural increase in activity this year, Rystad Energy said. In 2022, a rebound of activity is forecast in the Eagle Ford, Niobrara and Anadarko regions.
“Oil and gas activity and upstream spending in U.S. Land has been exposed to significant volatility in the last two years,” Artem Abramov, head of shale research at Rystad Energy, said in a statement. “Aggressive strategies from private operators in the U.S. shale patch have driven spending this year, but we anticipate significant growth in 2022 from public and private operators alike.”