U.S. Shale Producers Drilling Themselves into a Hole

 

Drilling and production are rising. Prices are declining. Companies are barely breaking even or losing money. Costs are starting to rise. And share prices are sliding.

 

Current oil prices are not sustainable according to Harold Hamm, the chief executive of Continental Resources (CLR), said in an interview on June 28.

 

Prices need to be above $50 per barrel to be sustainable and below $40 would force producers to idle rigs, Hamm said ("Harold Hamm warns oil prices below $40 will idle U.S. drilling", CNBC, June 28).

 

"While this period of adjustment is going on, drillers don't want to drill themselves into oblivion. Back up, and be prudent and use some discipline," he urged rival chief executives.

 

Many of Continental's leases are in North Dakota's Bakken and Oklahoma, where wells are typically more expensive to drill and yield less oil than some other shale plays.

 

The resurgence in shale drilling over the last year has been concentrated in the Permian Basin of Texas and New Mexico, where costs are much lower and yields higher.

 

There are now almost 370 rigs drilling for oil in the Permian compared with 50 in the Bakken, according to oilfield services company Baker Hughes.

 

The number of rigs drilling in the Permian has almost tripled since the end of April 2016, and the Permian now accounts for almost half of the rigs drilling for oil in the United States.

 

But even in the Permian, shale firms have struggled to make money with oil prices stuck below $50, raising questions about the sustainability of the drilling boom.

 

Many shale drillers claim they can drill wells profitability even with benchmark WTI prices below $50 as a result of significant cost reductions and improvements in efficiency.

 

But most shale firms were still losing money or at best breaking even in the first quarter of 2017, even before the renewed slump in prices.

 

Pioneer Resources says it has the largest acreage in the prolific Spraberry/Wolfcamp section of the Permian and low average royalty and acreage costs.

 

Pioneer has been praised by equity analysts for its active hedging programme that aims to protect cash flow from short-term volatility in oil prices.

 

But the company reported losses (negative net income) of $273 million in 2015 and $556 million in 2016.

 

Pioneer reported a further loss of $42 million in the first quarter of 2017, despite the substantial rise in oil prices compared the same period a year earlier.

 

Continental lost $354 million in 2015 and $400 million in 2016 before just about breaking even with net income of less than $0.5 million in the first quarter of 2017.

 

EOG Resources, another prominent producer, reported a loss of $4.5 billion in 2015 and $1.1 billion in 2016 before turning a small profit of $29 million in first quarter 2017.

 

Since the first quarter, WTI prices have fallen by more than $3.50 per barrel, or 7 percent, from an average of $51.78 in January-March to just $48.14 in April-June, intensifying pressure on shale producers even further.

 

Many shale firms have hedging programmes that should protect them from the decline in prices in the short term, but most have hedged only a small proportion of next year's production.

 

The current calendar strip allows producers to lock in WTI prices at just $50 for 2018, so most are waiting for a renewed rise in forward prices.

 

But every week they wait, their hedging cover declines by around 2 percent, assuming they have an average hedge maturity of 12 months.

 

In the meantime, producers are braced for cost inflation, with the major oilfield services firms pressing for price increases by the end of the year and into 2018.

 

Since WTI prices peaked in late February, shale producers have added more than 150 extra rigs drilling for oil.

 

The rig count is up by 430 over the last 12 months even though WTI prices are now $3 per barrel lower.

 

But share prices for all the major producers are sliding. Pioneer's share price is down almost 15 percent since the start of the year. Continental is down 39 percent. EOG has fallen 13 percent.

 

Many shale producers seem to be relying on OPEC to bail them out by cutting its own output further to drive WTI prices back above $50 per barrel.

 

But it not be rational for OPEC to cut output if the only consequence was to encourage continued growth in U.S. shale. Key OPEC producers appear unenthusiastic about further cuts.

 

If something cannot go on forever, it will stop. The slide in oil prices over the last four months is sending a signal to shale firms about the need to moderate drilling and production programmes.