U.S. Shale Drillers Struggle as Prices Plunge
North America's shale drillers are struggling with the renewed slump in oil prices, despite cutting costs, boosting output, and in some cases employing hedging to improve realised prices.
Stock prices for most of the main shale drillers have fallen faster than the price of U.S. light crude since the middle of April.
Spot WTI has fallen 20 percent since mid-April but the share price of Pioneer Natural Resources (PXD) has dropped 30 percent and Continental Resources (CLR) is down almost 40 percent over the same period.
Both companies increased production during the second quarter. Pioneer produced 197,000 barrels of oil equivalent per day (boepd) in April-June, up from 194,000 in January-March, while Continental reported output of 227,000 boepd, up from 207,000.
Pioneer's production is mostly from the Permian Basin and Eagle Ford in Texas, while Continental's operations focus on North Dakota's Bakken and Oklahoma.
Both companies reported that drilling and completion costs had fallen by 20-25 percent compared with the end of 2014, they told analysts during conference calls held in the first week of August to discuss their earnings.
Both companies are drilling wells faster than ever before, in the best case in just 13 days, which means they can squeeze out extra efficiencies by drilling the same number of wells with fewer rigs, or more wells with the same number of rigs.
Both are speeding up drilling time and boosting output per well by focusing on the most prolific shale layers in the most productive areas.
Both expect to grow their production this year compared with 2014, by 10 percent in Pioneer's case and 19-23 percent for Continental.
Yet neither company made money in the second quarter. Continental's net income was basically zero while Pioneer posted a net loss of $218 million.
In some ways, the two companies have opposite philosophies and strategies: the fact both are struggling to cope with the renewed slump in prices illustrates the challenge all shale firms face and the lack of good options.
Pioneer points to its active hedging programme as a key source of competitive advantage that will enable it to weather the slump better than its rivals.
Pioneer has hedged 90 percent of its forecast 2015 oil production at an average price of $71 per barrel, and the company has already established three-way collars to protect around 75 percent of its forecast 2016 oil production.
By contrast, Continental lifted its 2015 hedges in October 2014, realising a profit at the time, but gambling on a rebound in oil prices which has not happened and leaving the company exposed to full extent of falling prices.
But the biggest difference lies in their attitude to prioritising production growth versus capital discipline in the face of lower oil prices.
GROWTH AND/OR DISCIPLINE?
Pioneer has repeatedly emphasised its determination to continue growing its output aggressively even if wellhead prices remain below $50 per barrel.
The company confirmed its plan to add two extra drilling rigs per month during the second half of 2015 and eight more in the first quarter of 2016.
Pioneer is targeting compound annual growth in oil production of more than 20 percent between 2016 and 2018 even if prices remain in line with the current futures curve.
Repeatedly quizzed by analysts about whether the company was targeting production or returns, the company insisted its wells were highly profitable even at current prices, so it wanted to drill as many of them as possible.
"Why don't you pursue more of a return strategy than a growth strategy?" one analyst wondered. But the company disputed the distinction and insisted it was maximising returns by growing volume profitably.
Faster drilling, cost reductions and hedging will enable the company to meet its production targets despite lower prices.
"Do you see yourselves as part of the global market share war that we're seeing in the industry and that you're just going to outrun it and survive?" one analyst asked.
"That's right," replied Chief Executive Scott Sheffield.
Pioneer aims to use efficiency gains and smart hedging to survive the downturn even as others are forced to cut back.
"I personally think (Texas) shale oil will out survive LNG projects around the world, it'll survive new exploration projects, and they'll survive essentially all other shale plays in the U.S. in the Midland Basin," Sheffield said.
"The world needs the Permian Basin. And so eventually supply-demand's going to reset. And the longer it stays lower, oil prices are going to bounce back even quicker".
Pioneer foresees prices returning to the mid-$50s or even low $60s by the second half of 2016.
The company left just a glimmer of room for doubt. "We always get asked what commodity price would slow you down," Sheffield explained. "If oil prices go to $40 and stay at $40 for the next 18 months, we'll most likely slow down. But as long as our hedge positions and the (futures) strip occurs, there's no reason at this point in time to slow down."
The company would only make small losses this year at $40 and would hope to offset them by further efficiency improvements and cost reductions.
Where Pioneer focuses on profitable growth and outlasting competitors, Continental has repeatedly emphasised its disciplined approach to investment.
"We do not believe the current price environment is sustainable," Continental's chief financial officer told analysts, "and we will remain patient awaiting better commodity prices before deploying additional capital .. Our efficiency and cost improvements are allowing us to do more with less capital."
Chief Executive Harold Hamm warned bluntly: "I think the market rewarding people for jumping in, increasing production, rig count today in low commodity prices, I just don't see that as something that ought to be happening."
"Let the market rebalance. These reserves and these resource plays are not going anywhere and we all have a long future and that's the kind of way we look at it here."
Continental wants to use cost reductions and efficiency improvements to increase profits rather than grow output. It hopes to cut capital spending while maintain production roughly constant in 2016 at end-2015 levels.
The company told analysts it would be cash flow neutral in the second half of 2015 at WTI price of $60 while it would outspend cash flow by $150 million to $200 million at $50 per barrel.
The cash flow neutral price has come down sharply since the turn of the year and the company hopes to reduce it even more in the second half if necessary by squeezing costs even harder.
Continental could use any rise in prices or further cost savings to grow production in 2016, rather than leave it flat, but insists it is "committed to a disciplined approach".
PRIORITISING PROFITS
The difference between Pioneer and Continental is one of emphasis as much as strategy, profitable growth versus cutting capital spending while maintaining output.
But the fact that both companies have seen their share prices pummelled over the last four months highlights the awkward position in which all shale producers are stuck. Recent price falls have eliminated the advantage they have wrought from cheaper costs and faster drilling.
Individually, it makes sense to concentrate on maintaining or increasing output while cutting costs, hoping other producers will reduce their output. But with all the shale firms pursuing variants of the same strategy and OPEC also increasing its production the strategy is collectively suicidal.
Yet there is no easy way to organise a collective output cut or even a slower rate of growth among the shale firms because of antitrust law. Some shale producers seem to be hoping for other producers to cut first, either voluntarily or because of the threat of bankruptcy.
The shale sector's problem resembles the difficulties which airlines had until recently, growing capacity without making a profit. The airlines eventually learned to prioritise profits over capacity, but only after years of pain. The shale sector appears to be at the start of a similar learning curve.
By John Kemp
