The Fuse

Shale Industry on the Verge of a Slowdown as Companies Cut Capex

by Nick Cunningham | July 26, 2017

This week, Anadarko Petroleum became the first large U.S. oil company to slash its spending plans for 2017 in response to the most recent plunge in oil prices. After reporting a second quarter net loss of $415 million, Anadarko said that it would rein in its capital expenditures for the rest of the year. “The current market conditions require lower capital intensity given the volatility of margins realized in this operating environment. As such, we are reducing our level of investments by $300 million for the full year,” Al Walker, Anadarko Chairman, President and CEO, said in a statement.

More companies could follow Anadarko’s lead, paring back drilling plans amid more modest expectations for a recovery in oil prices.

More companies could follow Anadarko’s lead, paring back drilling plans amid more modest expectations for a recovery in oil prices. Whiting Petroleum Corp., a major producer in North Dakota’s Bakken shale play, said on Wednesday that it is slashing its 2017 budget by 14 percent.

After trading above $50 per barrel for much of the first and second quarter, WTI retreated sharply in June to the low $40s, although it has regained some ground in July. Top oil forecasters—from the EIA to investment banks such as Goldman Sachs—have all revised their expectations downward for oil prices for the second half of 2017. On July 26, Societe General became the latest investment bank to slash its price forecast, lowering its 2017 estimate for Brent from $55 to $50 per barrel. The weaker price performance is starting to impact U.S. shale production and growth.

Shale boom slowing

There are already early signs of a slowdown in the shale sector. The U.S. has added 235 rigs from the start of the year through the third week of July, a significant increase of more than 40 percent. But more recently, the additions have slowed to a trickle, with the industry deploying only six additional oil rigs since the end of June.

The world’s top oilfield services companies have voiced their belief that shale growth is decelerating.

The world’s top oilfield services companies have voiced their belief that shale growth is decelerating. Halliburton’s executive chairman Dave Lesar told investors on a recent earnings call that the shale industry was intentionally throttling back, not repeating the same mistake of drilling themselves into another depressed market. “Today, rig count growth is showing signs of plateauing and customers are tapping the brakes. This demonstrates that individual companies are making rational decisions in the best interest of their shareholders. This tapping of the brakes is happening all over the place in North America,” he said.

Schlumberger, the largest oilfield services company in the world, does not entirely agree. Schlumberger’s CEO Paal Kibsgaard argued on an earnings call that the shale industry is already overstretched, but instead of signaling out the recklessness of drillers, he cast blame on Wall Street. The drilling boom is “largely driven by the U.S. equity investors who are encouraging, enabling and rewarding short term production growth in spite of marginal project economics.” Kibsgaard said that so much production is coming online because “equity appreciation outweighs the lack of free cash flow, net income and return on capital employed.” He added that these “fast barrels” are actually damaging investors. But despite that fact, “this has yet to limit the investment appetite for additional production growth.” However, he ultimately asserted that there will be no choice but for the industry to moderate its pace of drilling later this year.

While Halliburton’s top executive had a much more favorable take on the state of mind within the shale industry, both oilfield services giants came to the same conclusion: The shale industry is on the verge of a slowdown.

Shortage of oilfield services

As producers have to contend with a weak oil market, oilfield services companies now have more leverage to hike their prices.

As producers have to contend with a weak oil market, the oilfield services companies now have more leverage to hike their prices. Equipment and rig suppliers took it on the chin over the past three years, as the dearth of drilling activity forced them to accept lower and lower rates for their services. The resurgence of drilling has tightened the market for rigs, equipment, frac sand, and well completion services, granting stronger leverage to companies like Halliburton and Schlumberger when they negotiate prices with oil producers. “The rig count is up. There are less underutilized assets sitting around, and that puts oil field services companies in a stronger position,” Rob Thummel, portfolio manager at Tortoise Capital Advisors, told the Wall Street Journal.

The FT reported that the supply of fracking crews is forcing drillers to idle some wells that have been drilled but not completed. As a result, the prices for fracking services have doubled from 2016 levels, and the supply constraints are likely to raise costs for producers and hamper production growth potential.

A new report from Wood Mackenzie finds that even some of the largest shale players won’t be cash flow positive until 2020.

Additionally, despite the strong gains in production in 2017, the rebound does not necessarily mean the industry is healthy. A new report from Wood Mackenzie finds that even some of the largest shale players won’t be cash flow positive until 2020. Moreover, because much of the industry is focusing on scaling up production rather than maximizing profits, they are shooting themselves in the foot. “Producers are being incentivized by investors to grow production and we think that has the potential to oversupply the oil market, with repercussions for oil price and profitability. Value could yet be destroyed rather than created,” Andy McConn, principal analyst at Wood Mackenzie, said in a statement.

How will production be affected?

While there are some early clues pointing to the drilling frenzy losing steam, the magnitude of the coming deceleration or contraction is still unclear. The rig count appears to be flattening out, but weekly estimates from the EIA suggest production is still on the rise, with output above 9.4 million barrels per day.

“If Wall Street rewards them for being more reserved with their activity levels and capital expenditures, then maybe it catches on.”

The decision by Anadarko, though, to slash its spending budget is one sign that oil companies are responding to weaker prices. It should be noted that Anadarko’s spending cuts are largely related to its international programs, rather than shale drilling specifically. However, the newfound caution could offer a path forward for struggling oil companies. “If Wall Street rewards them for being more reserved with their activity levels and capital expenditures, then maybe it catches on,” Mike Kelly, a Houston-based analyst for Seaport Global Securities LLC, told Bloomberg on July 24. If Anadarko’s stock plunges, however, “I think other people will be reticent about coming out and saying, ‘we’re cutting as well.’” In the first few trading days following Anadarko’s announcement, its stock jumped more than 2 percent. Now, the big questions are how many companies will follow Anadarko’s example and how more cutbacks would affect prices.

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