The Fuse

U.S. Shale Taps Brakes With WTI Below $50

by Nick Cunningham | January 09, 2019

WTI prices hit a cyclical peak at $76 per barrel in early October 2018, before falling by nearly half by the end of the year. Oil prices are starting to creep back up from the late-December low point, but very few analysts expect prices to return to the earlier highs.

The outlook for oil prices in 2019 is highly uncertain, but the effects of low prices are starting to wear down the U.S. shale industry. Some leading indicators suggest that drilling activity has already started to slow, while other signs indicate that oil executives could further rein in their ambitions for 2019 if prices fail to rebound from current levels.

The Dallas Fed’s business activity index, which broadly measures conditions facing energy firms in Texas and parts of Louisiana and New Mexico, plunged in the fourth quarter to a reading of just 2.3, down from 43.3 in the third quarter.

Shale drilling slowdown
Recent data from the Dallas Federal Reserve suggests a slowdown from the U.S. shale industry is already underway. The Dallas Fed’s business activity index, which broadly measures conditions facing energy firms in Texas and parts of Louisiana and New Mexico, plunged in the fourth quarter to a reading of just 2.3, down from 43.3 in the third quarter. Readings near zero suggest activity was flat quarter-on-quarter; positive territory indicates growth, while a negative figure means industry activity contracted. Moreover, roughly 53 percent of oil and gas executives that responded to the Dallas Fed survey said that the recent drop in oil prices caused them to lower expectations for capital spending in 2019. Only 31 percent said the plunge in oil prices would have no impact on 2019 spending decisions.

“I believe it is going to require $70 per barrel West Texas Intermediate (WTI) to justify continued development of unconventional reserves,” one anonymous oil and gas executive said in the Dallas Fed survey. “Lifting costs of $40–$50 per barrel are needed to operate producing wells at a marginal profit, but sunk capital (i.e., leasehold acquisition) costs and administrative overhead costs are real costs as well, and those costs require an additional $10–$20 per barrel WTI price to result in marginal profitability.”

That sentiment is backed up by estimates from Bloomberg New Energy Finance, which puts breakeven prices for shale drilling in the Sprayberry (Permian basin) at between $32 and $47 per barrel. But the bottom quartile of wells in Upton County, for instance, have a breakeven price as high as $65 per barrel. Separate estimates from R.S. Energy and the Wall Street Journal put all-in breakeven costs for the Permian at $51 per barrel, $57 in the Eagle Ford and $64 in the Bakken.

In the first week of January, WTI traded in the high-$40s per barrel. After factoring in discounts for oil in Midland, it is conceivable that many shale drillers without hedging protection are in negative territory.

Budgetary pressure could force companies to scale back their ambitions for this year. “I expect the dramatic, unexpected and significant drop in oil prices will significantly decrease revenue for the first half of 2019. I intend to mitigate this by stopping all drilling and deferring any new projects,” a second anonymous oil executive told the Dallas Fed.

Occidental Petroleum said in an investor presentation that the company could lower capital expenditures for 2019 if WTI prices remain low. Occidental says it will spend $5-$5.3 billion if WTI averages $60 per barrel, but spending would fall to $4.8-$4.9 billion if WTI averaged $55 per barrel. If WTI averages a meager $50 per barrel, Occidental would lower 2019 capex to $4.4-$4.5 billion. Analysts had expected a 2019 spending plan of about $5.1 billion.

“The overall picture is of an unsettled industry, scaling back activity and pessimistic about 2019”

“The overall picture is of an unsettled industry, scaling back activity and pessimistic about 2019,” Standard Chartered concluded in a note after reviewing the data and comments from the Dallas Fed survey.

A deceleration in shale drilling will first be felt by oilfield service companies. Hi-Crush Partners, a supplier of frac sand used in drilling operations, saw its share price plunge by more than 15 percent on January 7 after reporting a sharp slowdown in sales of its product in the fourth quarter. The sand supplier blamed weak completion activity from the shale industry. “Well completion activity slowed significantly in the fourth quarter, impacting sales volumes and pricing primarily of Northern White sand, and to a lesser extent in-basin sand,” Robert E. Rasmus, Chairman and Chief Executive Officer of Hi-Crush, said in a statement.

Data on well completions also suggests the industry slowed activity in the last few months of the year. “After reaching a peak in May/June, fracking activity in the Permian Basin has gradually decelerated throughout the second half of 2018,” Rystad Energy senior analyst Lai Lou said in a statement. According to Rystad, U.S. drillers averaged 48 fracked wells per day between April and August 2018. That figure dipped to 44 by November. “Looking at preliminary data for November, we see evidence that seasonal activity deceleration has likely started in all major plays except Eagle Ford,” Lou adds. Lou singled out the Bakken and Niobrara as regions that have seen “a considerable slowdown.”

Other prominent data points also lend weight to the notion that shale E&Ps are scaling back. The rig count has flattened out since November. U.S. weekly oil production figures from the EIA have been stagnant over the past two months as well, although the weekly surveys are less accurate than the retrospective monthly data that comes out on a several-month lag. Still, it seems that the blistering production growth rate exhibited over the first three quarters of 2018 may have come to a halt in the last two months of the year.

A more sluggish pace of drilling is a clear indication that not only is the shale industry price sensitive, but that many companies struggle with WTI prices at or below $50 per barrel.

A more sluggish pace of drilling is a clear indication that not only is the shale industry price sensitive, but that many companies struggle with WTI prices at or below $50 per barrel.

How will slowdown affect production?
Nevertheless, 46 percent of oil and gas companies that responded to the Dallas Fed survey said that growing production was their top priority this year. That stands in sharp contrast to the pressure from many shareholders over the past few years to focus on capital discipline, profits and shareholder payouts. Less than ten percent of companies in the survey said that “return capital to shareholders and/or owners” was their primary goal this year.

In other words, at least some in the shale industry remain eager to continue drilling even in the face of budgetary pressure. There are clear signs that some shale drillers are tapping the brakes, but there is no consensus on how this might impact over U.S. oil production growth. For now, major energy forecasters, such as the IEA and the U.S. EIA, have not significantly altered their heady production growth estimates for U.S. shale for 2019.

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