Ukraine war reignites US oil debate
Calls for more oil production in the U.S. are growing louder following Russia’s invasion of Ukraine. But after years of losing money from aggressive drilling, companies are reluctant to return to old ways.
Since the onset of Russia’s war in Ukraine, which has driven up global oil and natural gas prices to their highest levels since 2008, the U.S. oil and gas industry launched a full court press to lobby for a more friendly drilling environment. Taking to the airwaves to denounce the Biden administration’s climate policies for holding back American energy production, industry lobbyists and trade groups are calling on the U.S. government to back a renewed drilling campaign.
But the solutions the lobbyists put forward – offering up more public lands for drilling, permitting new LNG export terminals – are longstanding wishes of the industry. In addition, because new infrastructure would take years to have any impact, such proposals have very little to do with the current crisis.
In reality, there are very few obstacles standing in the way of more drilling. While U.S. oil production has been steadily recovering since it collapsed at the beginning of the pandemic two years ago, drilling activity remains relatively subdued compared to the fracking craze in the decade prior to 2020. That is exactly how oil companies and their investors prefer it.
Supply restraint comes after “decade of financial failure”
Always a politically sensitive topic in the U.S., the blame-game over high gasoline prices is reaching a fever pitch. But the sudden finger-pointing over high gasoline prices is “divorced from an understanding of what happened over the last decade. It’s designed for people who tuned into oil prices starting in September,” Clark Williams-Derry, an energy finance analyst at the Institute for Energy Economics and Financial Analysis (IEEFA), told Gas Outlook, referring to the run up in global crude oil prices that began in the middle of last year.
“But this is not something that started last September,” he said. “This is a decade of financial failure that is completely ignored in today’s rhetoric. It’s a decade of overproduction, terrible financial mismanagement, massive losses of stock value, massive amounts of money written off in bankruptcy.”
Top U.S. shale producers burned through over $300 billion in cash between 2010 and 2020, and the chronic financial losses destroyed trust from investors. The pandemic-induced collapse in the oil market in early 2020 decisively ended the years-long spending binge.
Now, even oil prices rocketing up to the highest point since 2008 is not sparking a drilling boom. Investors have demanded restraint from drillers, and want any profits returned to them.
“Pioneer will stay with our plan. We announced a capex plan, as I said, regardless of whether it’s $150 oil, $200 oil, or $100 oil we’re not going to change our growth plans,” Pioneer Natural Resources CEO Scott Sheffield said in a Bloomberg interview in February.
When asked what he would do if President Biden called him up to ask for more supply, Sheffield said even then he wouldn’t ramp up.
“I’ll tell him we have a pact with…it’s all about the shareholders. Our shareholders own this company. They want a return of cash,” Sheffield said. “We know what’s happened when we increased US shale too much over the last ten years. We’ve had a collapse.”
Williams-Derry said the shale industry started posted much better financials when they slammed the brakes on drilling. Lower spending, along with higher prices, now has them posting large profits.
“This is the moment that the fracking sector has been waiting for. High prices and relatively low capex. That’s what generates cash flow and allows them to return to cash to long suffering investors who have been waiting for more than a decade for this kind of payout,” Williams-Derry said.
Can U.S. shale increase production at today’s prices?
Immense political pressure and sky-high prices may yet coax drillers off the sidelines. Production has climbed by roughly 500,000 barrels per day between January and December of last year, and is expected to continue to grind higher. The U.S. Energy Information Administration expects U.S. production to average 12 million barrels per day (mb/d) in 2022, before rising to 13 mb/d next year.
Much of the production increases are coming from the oil majors. ExxonMobil said it would increase production by around 100,000 barrels per day in the Permian basin in West Texas this year, and Chevron said it would add 60,000 barrels per day. Private oil companies, who do not have to answer to shareholders, are also a source of growth.
“US oil supply is clearly surging, returning far faster than market consensus had expected, particularly in shale oil regions. While the boom is being led by the Permian Basin it is spreading to other areas,” Emily Ashford, an energy analyst at Standard Chartered, told Gas Outlook.
But in addition to a short leash from investors, the oil industry is also facing bottlenecks for supplies and labour. For example, drillers are having trouble sourcing enough sand used in the hydraulic fracturing process.
“Producers are having trouble getting frack crews, they’re having trouble getting labour, and they’re having trouble getting sand…that’s going to keep anybody from growing,” Sheffield said in the Bloomberg interview. “Even if the president wants us to grow, I just don’t think the industry could grow anyway.”
“Now, with supply chain challenges, it makes any kind of attempt to grow now — and at a rapid pace — very, very difficult,” Vicki Hollub, CEO of Occidental Petroleum, said at an industry conference in Houston on March 8.
Triple-digit oil prices may be appetizing, but the combination of sector-specific bottlenecks and broader inflation will push up costs for new drilling. “The headwinds of ESG mandates, shareholder demands for capex discipline and pressure to return capital, rising service costs and a tight labour market shouldn’t be dismissed, these are still powerful forces,” Ashford said.
In addition, a lot of recent production increases were the result of companies bringing online wells that were already drilled. These so-called “drilled but uncompleted wells” (DUCs) were low-cost ways to add output.
“The surge in US output in H2-2021 was largely driven by a rundown of the DUC well inventory. However, this rundown will likely start to hit its limits during 2022, as the most economic component is completed, and there will be some that will never be completed,” Ashford said. “Once low-hanging fruit has been removed, the pace of drawdowns will slow until no suitable inventory remains. New drilling will need to increase if growth momentum is to be maintained.”
But it isn’t clear how fast the industry will increase drilling. After years of losing money, companies are reluctant to upend an arrangement that is working for them.
“They could ramp up for sure. If they were willing to go back to zero free cash flow, they could increase their production pretty dramatically,” Williams-Derry said. “The industry’s refusal to continue overproduction is, in part, at the root of high prices right now. It’s also at the root of their financial success right now. Not drilling is very good for the industry.”