US shale pioneers circle the wagons
Ed Crooks
ft.com
If there is “price war” in the oil market, as Adel Abdul Mahdi, Iraq’s oil minister, has suggested, the US shale industry is refusing to take flight at the first sound of gunfire.
As the International Energy Agency, the watchdog backed by developed economies, said on Wednesday, the fall in oil prices by more than 25 per cent since June is set to cause a cut in investment by US shale companies.
Some that have not yet decided their 2015 capital spending budgets have said that they are reassessing their drilling programmes. A few that had already set out spending plans have in the past couple of weeks announced cuts. So far, though, they look like tactical withdrawals to concentrate their efforts where they will be most effective, rather than admissions of defeat.
Activity is already starting to slow. There were 1,568 rigs drilling for oil onshore in the US last week, 41 fewer than in mid-October, according to Baker Hughes, the oil services group.
That figure is likely to fall further over the coming months. Halcon Resources, which operates in the Eagle Ford shale of south Texas and the Bakken of North Dakota, said on Monday it planned to run just six rigs next year, compared with the eight it is running now and the 11 it had previously planned for 2015. Other leading shale oil companies have announced reductions in their capital spending plans: Continental Resources cut its 2015 budget from $5.2bn to $4.6bn; Rosetta Resources said it would spend about $950m next year, down from $1.2bn in 2014; and ConocoPhillips said it planned to spend less next year than the $16bn it is spending this year.
Gambling with house money
Harold Hamm, chief executive of Continental Resources, has made a bet that the recent pullback in oil prices will be shortlived
Other companies have suggested they are likely to follow suit. EOG Resources, one of the most successful shale oil producers, said at the time of its third-quarter results last week that it planned to ensure that its capital spending plus its dividend payments were in line with the cash flow it has coming in, and that would probably mean reduced activity in some areas.
The pressure on shale producers is not so much profitability as liquidity. William Thomas, chief executive of EOG, said last week that even if oil fell to $40 the company could still earn a 10 per cent return in some areas, including the Bakken and the Eagle Ford shales.
Pearce Hammond, an analyst at Simmons & Co, says that rate of return calculation is less important than another critical question: “How much cash do you have going out the door to drill the wells, and how much do you have coming in?”
Debt has fuelled the shale boom, as producers outspent their cash flows and needed to borrow to fund investment. As prices fall, the companies that borrowed too much will find themselves under strain.
The bond markets have already started to reflect some nervousness, with yields on junk bonds in the energy sector rising to their highest level in more than a year.
Sean Sexton, an energy specialist at Fitch, the rating agency, says that last year he was surprised by how investors’ enthusiasm for oil companies’ debt was such that even low-rated companies were able to borrow at rates below 6 per cent. Now that discrepancy appears to be being corrected.
Nevertheless, although oil prices at present levels of about $75-$80 for US crude will put pressure on some marginal companies, others should be fine, even if they still need to borrow to fund their drilling, Mr Sexton says.
“They may have to pay a bit more in interest costs, but it’s not like they’re not going to be able to go to the market and raise money.”
Pioneer Natural Resources, another shale oil producer, showed last week that the equity market was still open as a source of funds, announcing a planned share sale to raise $1bn to help finance its investment plans.
While the debt and equity markets remain supportive, shale drilling activity is likely to ease off rather than collapse.
Although they may be drilling less than they had expected, oil companies will also be focusing on maximising the production from the rigs they are using.
John Richels, chief executive of Devon Energy, told analysts on a call last week that the company expected to cut the number of rigs it had running in the Mississippian region of northern Oklahoma and southern Kansas, described as an “emerging” business, and to shift them to more productive areas.
Companies are also constantly pushing to use their rigs and other equipment more efficiently.
Hess, one of the leaders in the Bakken shale, said in a rare presentation to analysts on Monday that it had cut the cost of each well there to $7.2m in the third quarter, down from $9.5m two years ago.
Chesapeake Energy, founded by shale entrepreneur Aubrey McClendon but under new management since last year, said last week that it had cut its capital spending by 60 per cent from $14.2bn in 2012 to an expected $5.7bn this year, but had still increased production from its continuing businesses by 12 per cent in the first nine months of 2014 compared to the equivalent period of 2013.
It is this sort of improvement that encourages shale producers to continue to project growth in output.
Devon is talking about 20-25 per cent growth in its oil production next year, with capital spending about the same as this year, while EOG is projecting “double-digit” growth to 2017, if US crude stays at about $80. Continental is projecting growth of 23-29 per cent in its output next year, and Pioneer expects 16-20 per cent each year to 2016.
These growth rates are based on annual averages, and these companies have been growing rapidly during 2014, so the comparisons with the end of this year will be less impressive.
The companies’ predictions will not necessarily be fulfilled; it is important for them to show their investors they are still growing, so they have a temptation to err on the side of optimism. The IEA expects the impact of falling investment to show up not immediately, but in a decline in production in the “medium term”.
Still, if the statements of the shale industry’s leaders are even broadly accurate, it looks as though oil prices may have to go significantly lower before US oil production starts to fall.
Gambling with house money
As the oil price has been falling, many US shale executives have emphasised that they have a safety net in hedging strategies using futures and options that will protect their revenues against further falls in the crude price for the next year or two. Not Harold Hamm, chief executive of Continental Resources.
He has decided to do without a net, announcing last week that the company had sold all of its hedges, for this year, 2015 and 2016, to raise $433m. If the oil price does fall further, Continental will face the full brunt of it.
As Mr Hamm, who is the founder of one of Continental’s ancestor companies, owns about 68 per cent of the shares, he is taking a gamble principally with his own money.
He is also betting the way he always has. He has long argued that any significant drop in oil prices could not last for long, and on a call with analysts last week he repeated the company’s “belief that the recent pullback in oil prices will be shortlived.”
He added: “We feel like we're at the bottom rung here on prices, and we'll see them recover pretty drastically, pretty quick.”
Like many in the US oil industry, Mr Hamm sees the long-term trends, with demand rising as hundreds of millions of people in emerging economies raise their standard of living, and constraints on supply in many parts of the world, especially the Middle East, and concludes that crude prices are likely to head higher.
A couple of years of weaker prices, with slower production growth from shale companies, could be a good thing to allow global demand to “catch up” with the supply boom in the US, he said.
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However, the oil market is always tricky to predict, and has recently become more volatile after years of relative stability.
Mr Hamm this week had some good news on his divorce settlement for his ex-wife Sue Ann, which was set by an Oklahoma court at $973m; significantly less than the multiple billions that some had expected, and about 7 per cent of his net worth.
His decision on hedging could end up having a much more significant effect on his fortune.
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