The world’s most powerful oilman is betting big against America’s shale industry.
Saudi energy minister Prince Abdulaziz bin Salman was clear after the recent OPEC meeting at which the cartel agreed to keep stoking an oil-price rally with deeply curtailed production. The battered U.S. oil sector was no longer in a position to wreck his efforts with a new drilling binge.
Shale’s era of “drill, baby, drill is gone forever”, said the prince.
The claim raised eyebrows in the shale patch, given the sector’s short and disruptive history—including its stunning recovery from a price crash six years ago.
But Abdulaziz was echoing a new Wall Street-enforced mantra in the shale business, where investors are forcing operators to resist their instincts to launch another rally-sapping output surge even as oil prices rise.
Since prices slumped last year, executive after executive has proclaimed a new shale religion of high returns and shareholder payouts, all predicated on keeping a lid on production.
“I think the worst thing that can happen right now is U.S. producers start growing rapidly again,” Ryan Lance, ConocoPhillips CEO, told an industry conference this month.
The question is whether such discipline can last as the Saudis ratchet prices higher.
A 70% rise in the crude price since November has U.S. oil trading at around $65 a barrel, above pre-pandemic levels—and more than enough for most producers to turn a profit.
Less than 11 months after a crash that saw U.S. oil prices plunge below zero, put scores of companies out of business and forced others to slash spending and shut wells, America’s frackers are suddenly looking flush.
“There’s a tidal wave of cash coming through at current oil prices,” said Raoul LeBlanc, vice-president at consultancy IHSMarkit. “It could be a real good financial year for these guys.”
U.S. output may even start expanding again later this year, according to some analysts, although a recovery to the record high of 13 million barrels per day (MMbbl/d) struck is distant.
Rystad Energy, a research company, expects total US crude output to hit at least 11.6 MMbbl/d by the end of 2021, from under 11.2m in December. A bigger surge is likely in 2022.
OPEC’s willingness to push prices higher is persuading many analysts to revise up their forecasts for U.S. oil supply.
Last week’s decision by the cartel not to ease back on its cuts “has not just left the door to higher prices open, it has taken that door off its hinges and chopped it up for firewood”, said a Standard Chartered note.
Shale operators could now hedge future production at the higher prices, the bank’s analysts said.
If current prices endure, producers will eventually need to figure out how to spend their windfall. Many have pledged to reinject just 60% to 70% of cash flows into production, leaving the rest for debt repayments and shareholders.
Fourth-quarter capital expenditure amounted to just 55% of cash flow, said Rystad, unprecedented prudence in a notoriously profligate sector.
If the discipline sticks and oil prices hold above $55, free cash flows could swell this year to about $30 billion, according to IHSMarkit.
“There’s a general sense that they’re winning by letting the price go up and bail them out,” said LeBlanc.
At $60, shale operators would even generate enough free cash to meet more than $170 billion of debt obligations over the next five years, reckons Rystad.
Some analysts now think operators could accomplish something recently unthinkable in the shale patch: repair balance sheets and keep investors happy, while also pushing output higher again.
“At some point, capital discipline and that new religion will do what it always does—recede into the background,” said Ian Nieboer, a managing director at consultancy Enverus. “There’s nothing that doesn’t work at $65 a barrel.”
So far, private equity-backed drillers, which unlike their public rivals are under no pressure to hold back growth, are leading a recovery in drilling and fracking activity.
But publicly held shale specialists such as EOG Resources and Pioneer Natural Resources may also now bring in enough cash to start increasing again. Supermajor Chevron, meanwhile, this week unveiled an aggressive plan to increase its Permian output.
“Some of the well-positioned companies are justified to try and grow,” Robert Clarke, vice-president of upstream research at Wood Mackenzie, said. “They’ve paid down debt, they don’t have much leverage on the balance sheet, they already pay a dividend, and they can drill very profitable wells at $65 a barrel.”
OPEC may not need to worry just yet. Clarke said the rig count was rising at about half the pace of 2017, when the sector bounced back from another price crash brought about by the cartel.
On Friday, oilfield services company Baker Hughes’s much-watched count of U.S. oil rigs for the week dropped by one—another signal that operators are keeping their powder dry.
And decisions to deploy more rigs now will not yield new production for months.
U.S. operators also need to believe that Saudi Arabia will keep stoking the rally. It is less than 11 months since the kingdom’s price war and the pandemic triggered the worst crash in the U.S. oil sector in decades.
But a slow and precarious recovery—unthinkable six months ago—is under way. Another showdown may also already be looming.
“They’re trying to creep up, just to a point below the threshold where it gets OPEC’s attention,” Alex Beeker, principal analyst for corporate research at Wood Mac, referring to shale operators’ steadily rising rig count.
“For now, they seem to be below that. But OPEC can and will respond if shale steps out of line.”
Energy Source is a twice-weekly energy newsletter from the Financial Times. It is written and edited by Derek Brower, Myles McCormick, Justin Jacobs and Emily Goldberg.