Even with oil prices above $100 a barrel and gas prices averaging over $4 a gallon at the pump, frackers show little interest in ramping up output.
Companies including Devon Energy
and Diamondback Energy
have resisted increasing production. Instead, they are rewarding shareholders with juicy dividends and buybacks.
That’s despite some calls to increase output to help lower gasoline prices.
So what would it take for U.S. shale companies to increase output? Turns out, there are several factors at play.
For starters, the industry faces a dilemma, says Rob Thummel, portfolio manager and senior managing director at Tortoise, a firm that manages about $8 billion in energy-related assets. U.S. producers are waiting for the Organization of the Petroleum Exporting Countries (OPEC) to return to full production. He suggests that may happen this year.
Yet OPEC appears to be waiting to see how the U.S. and Iran hash out the removal of sanctions. If sanctions are lifted, Iranian oil may flood the market, and OPEC may be less interested in returning to full output, Thummel says.
“There’s this dance being played between OPEC and the U.S. producers, and that’s what I think is holding back U.S. producers,” he says.
They also may need to test how receptive investors are to higher output levels after spending the past few years convincing buyers that the firms aren’t back to their free-spending ways. Energy was the worst-performing S&P 500 sector in the past decade as the focus was not on stock performance but on production growth. During that time shale production grew substantially and the U.S.’s position as a global crude-oil and natural-gas producer grew significantly.
Kari Montanus, senior portfolio manager for the $2.8 billion Columbia Select Mid Cap Value Fund
whose No. 2 holding is Devon Energy, says the history of U.S. oil producers is boom-and-bust, especially the exploration and production companies.
“Even when oil was at a reasonable level, these companies spent away their free cash flow, and always were issuing stock, generating net-negative free cash flow. The stocks never were sustainable outperformers,” Montanus says, adding that major oil producers such as Exxon Mobil
could fit in that category.
The mindset of hyper growth at the expense of capital discipline began shifting ahead of the pandemic. However, the onset of Covid-19 caused significant declines in oil prices, and producers reduced drilling activity, which also led to staff reductions and many of those individuals found work in other sectors. That’s also contributed to the muted oil-output response.
“Oil and gas drilling still requires a lot of manual processes. There’s technology associated with it, but it still requires people and there’s just not as many people going forward. So that’s kind of how we got here,” Thummel says.
Production is rising
Despite public companies capping output, crude-oil production is up, according to the U.S. Department of Energy’s Energy Information Administration. Most recent data show the U.S. pumped about 11.6 million barrels per day (bpd) of the sticky stuff, up 4.4% versus a year ago. Just before the pandemic, the U.S. was close to producing 13.3 million bpd. Almost all of that increase comes from private companies in the Permian Basin, Thummel says. Additionally, oil majors Exxon and Chevron said they plan to increase production in the region.
He expects to see an additional 500,000 barrels daily this year on top of that total, but the U.S. won’t reach pre-Covid levels until 2023. Thummel also notes it can take about six months for companies to significantly boost production.
Part of the hesitation by public companies to boost production is the murky outlook for oil production in both the short and long term, Montanus and Thummel say. Deferred energy futures prices suggest more oil will spill on the market, as longer-dated prices are lower than nearby prices.
These producers may also be trying to figure out where they fit in the future. There’s a push for energy independence and energy security from oil-producing nations, but energy independence also looks a lot like renewable energy, which is growing. The rise of environmental, social and governance (ESG) investing means some people refuse to buy fossil fuels companies, Montanus adds.
Thummel believes if the world energy markets need U.S. oil, producers will ultimately raise production. But at the same time, they’re trying to figure out their niche, and that just might be proving their business models are economically sustainable. Cash flow yields for companies in shale oil are generally three to four times higher than the S&P 500 at $70-a-barrel oil. Returns like that are attracting investors, including Warren Buffett, who is scooping up Occidental Petroleum stock.
Oil producers are cognizant that “nobody wins” with oil over $100 since it eventually reduces demand long-term, he adds, with the sweet spot globally for producers and consumers between $60 and $80.
Memories are also pretty fresh after two sharp crashes, once after oil rose to $100 in 2014 amid the OPEC price war and then 2020’s Covid rout.
“Those are pretty recent and were devastating to the industry. Producers are just trying to navigate and keep that from happening again,” Thummel says.
Debbie Carlson is a MarketWatch columnist. Follow her on Twitter @DebbieCarlson1.
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