Chronic underinvestment could drive oil prices higher in 2022

Hardened Americans struggling with soaring inflation are finally getting a break. After relentlessly rising, prices at the pump are heading south, with national average gasoline prices falling to a 10-week low at $ 3.28 per gallon, according to AAA. Fuel prices began to stabilize after President Joe Biden announced the largest ever release of the strategic oil reserve on November 23, although experts dismissed it as a simple band-aid. While many have blamed the Biden administration for the high gas prices, the real culprit has more to do with Wall Street than Pennsylvania Avenue.

The genesis of today’s high gas prices can be attributed to the financial pressure on oil companies from a decade of devastating losses and low returns to shareholders that have forced them to radically change their business models. For years, Wall Street has pressured oil and gas companies to cut capital spending and reallocate their cash to financial goals like increasing dividends and buyouts, paying down debt, as well as decarbonization, after the fracking revolution left the patch of American shale bleeding deeply and deeply into debt.

As a result, investment in new wells has collapsed 60% since its peak in 2014, causing U.S. crude oil production to fall by more than 3 million barrels per day, or nearly 25%, just by the time the Covid virus hit, then failed to recover with the economy.

No drilling

With Wall Street blowing its neck, America’s shale is literally running on empty: According to the US Energy Information Administration’s latest drilling productivity report, the United States had 5,957 drilled but unfinished (DUC) wells in July. 2021, the lowest for every month since November 2017 from nearly 8,900 at its peak in 2019. At this rate, shale producers will need to sharply step up the drilling of new wells just to maintain the current production clip.

The EIA says that the sharp decline in UCRs in most of the major onshore oil-producing regions in the United States reflects more well completions and, at the same time, less new well drilling activity, evidence that producers of shale have kept their commitment to drill less. While the higher completion rate of more wells has increased oil production, particularly in the Permian region, the completions have sharply reduced DUC inventories, which could severely limit the growth of oil production. in the United States in the coming months.

The two main stages in commissioning a horizontally drilled and hydraulically fractured well are drilling and completion. The drilling phase involves dispatching a drilling rig and crew, who then drill one or more wells at a rig site. The next phase, well completion, is typically performed by a separate team and involves casing, cementing, perforating and hydraulic fracturing the well for production. Typically, the time between the drilling and completion stages is several months, leading to a large inventory of DUCs that producers can maintain as a working inventory to manage oil production.

According to data from S&P Capital IQ, 27 major oil producers tripled their capital spending between 2004 and 2014 to $ 294 billion, then reduced it to $ 111 billion last year. Once the old wells were plugged, the new ones were not available to quickly close the production gap. The question is, how long will the holdback of publicly traded oil companies last? Capital spending is expected to hit around $ 135 billion next year, a 21.6% year-over-year jump, but still less than half of the 2014 level.

Returns to shareholders

In addition to severely limiting new drilling activities, the US shale has also kept its commitment to return more money to shareholders in the form of dividends and share buybacks.

A recent report by the progressive advocacy group Accountable.us says 16 of the 24 major U.S. energy companies increased their dividends this year, while 11 paid special dividends totaling more than $ 36.5 billion. That’s a pretty impressive payout ratio considering the industry has so far reported $ 174 billion in profits this year. Indeed, “variable dividends” that allow companies to raise their dividends when times are good and lower them when the going gets tough have become a tool of choice for oil and gas companies.

Related: Gasoline Prices In The United States Yet To Peak

Meanwhile, oil and gas companies spent a more modest $ 8 billion on share buybacks, although ExxonMobil ((NYSE: XOM) and Chevron (NYSE: CVX) have pledged to buy back up to to $ 20 billion in stocks over the next two years. The energy sector has seen strong equity gains in the current year, which could explain the reluctance to overspend on buybacks actions.

However, the main reason that oil prices are expected to stay high over the coming year is OPEC discipline:

“You have a cartel that’s traditionally as disciplined as Charlie Sheen’s drinking, and over the past year or so, they’ve been as disciplined as Olympic gymnasts,” Oil Price president Tom Kloza told CNBC. Information Service.

Oil shortage

According to the IEA, crude consumption is expected to improve to 99.53 million barrels per day (bpd) from 96.2 million bpd this year, leaving it within a hair’s breadth of 2019 daily consumption of 99.55 million barrels. That will depend, of course, on the world’s ability to quickly get a handle on the new Omicron variant of Covid-19.

Higher oil demand will put pressure on OPEC and the U.S. shale industry to meet demand. But let’s not forget that many OPEC countries are already struggling to ramp up production, as the US shale industry faces investor demands to stay on track with spending. So far, the US shale industry has not responded to rising oil prices as it had before, with aggregate US production of 11.2 million bpd in 2021, up from a record close to 13 million bpd at the end of 2019. American production is only expected to increase. from 700,000 b / d in 2022 to 11.9 b / d, according to Claudio Galimberti, senior vice president of analysis at Rystad Energy.

Canada, Norway, Guyana and Brazil could try to close the gap between supply and demand, but several Wall Street punters are betting that this will not be enough and that oil prices will remain high.

In fact, Barclays predicted that the price of the WTI contract would drop from the current rate of $ 73 to an average price of $ 77 in 2022, noting that the Biden administration’s sale of oil from the Strategic Oil Reserve is not. a sustainable way to lower prices. Barclays says prices could go even higher than this forecast if COVID-19 outbreaks are minimized and thus allow demand to grow more than expected.

Goldman Sachs shares this bullish outlook and has predicted a Brent price of $ 85 per barrel by 2023, up from $ 76.30 currently.

By Alex Kimani for Oil Octobers

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Felix J. Dixon