The Fuse

U.S. Shale Activity Picks Up Even As Problems Remain

by Nick Cunningham | January 05, 2021

The U.S. oil industry was handed a massive gift by the leaders of OPEC+ on January 5. Not only did OPEC+ decide to mostly hold off on another sizable production increase, but Saudi Arabia voluntarily said that it would cut production by another 1 Mb/d for February and March.

The announcement comes amid signs that the U.S. shale industry has begun to step up drilling once again. There is almost no chance of a full recovery anytime soon, but with WTI back above $50 per barrel, U.S. shale drillers have pulled back from the abyss.

Dallas Fed survey shows signs of recovery
On December 30, the Dallas Fed released its quarterly energy survey, which offers an important gauge into the health of Permian frackers and their servicers. In recent quarters, the survey has detailed abysmal numbers, and included cries for help from executives that respond to the publication.

“We see continuing optimism fueling some greater activity in 2021.”

But the fourth quarter edition revealed the first positive reading for the survey’s broad “business activity index” since early 2019. A positive reading is an indication of growth; a negative reading signals contraction. Production data was flat, and employment continued to decline, but capex numbers increased in the fourth quarter. The comments section, which offers a chance for executives to anonymously air their thoughts (or grievances), contained a considerably more upbeat tone. “We see continuing optimism fueling some greater activity in 2021,” one respondent said.

On the ground, signs of a recovery are also evident. Local news outlet The New Mexican reports an increase of truck traffic and also a surprisingly decent revenue outlook for New Mexico’s state budget. “Oil and gas did not collapse like was feared,” David Abbey, director of the Legislative Finance Committee, told The New Mexican.

The rig count has climbed slowly but steadily in recent months. The Permian rig count is up to 175, up from a bottom of 117 last August, but that is still a far cry from the more than 400 active rigs in the Permian prior to the pandemic.

In fact, the signs of life in the shale industry do not mean that production will return to pre-pandemic levels, or that the shale industry in the aggregate will become profitable. It is important to note that by some estimates, the industry has cumulatively posted more than $300 billion in negative free cash flow since 2010. The pace of burning through capital could change, and consolidation could improve the outlook, but the challenges remain just as formidable as they did before the pandemic.

Dwindling access to capital and the dramatic shift in the investment climate towards the clean energy transition poses a daunting challenge to any substantial recovery for shale drilling. “I think shale is going to struggle and I don’t think it’s going to go back to the 2019 highs for the simple reason that investors don’t have the appetite to invest,” Amrita Sen, chief oil analyst at Energy Aspects, told Bloomberg Television. “We all know that shale is cost-intensive, they have to constantly drill. So, if the money doesn’t flow, they are going to struggle to recover.”

The industry is still a shadow of its former self.

The EIA’s last Drilling Productivity Report predicted that U.S. shale would lose another 137,000 barrels per day in output in January, compared to a month earlier. Drilling activity may be back from a low point reached six months ago, but the industry is still a shadow of its former self.

OPEC+ offers boost
OPEC+ members agreed to very slight increases in output, rather than the scheduled 0.5 million-barrel-per-day increase previously in the works. That, combined with the stated commitment from Saudi Arabia to voluntarily cut another 1 Mb/d, significantly changes the near-term outlook for crude oil prices, potentially giving shale drillers a boost. It comes at a time of serious concerns about Covid-19 and its impact on oil demand.

“The Saudi move, if realized, is not only offering a soft pillow to the oil market, but also a full set of blankets, bed covers and most likely the bed itself,” Bjornar Tonhaugen of Rystad Energy said in a statement. “The bulls are now jubilant over the Saudi commitment, but it is quite difficult to swallow the added curtailment size. It’s just too good to be true!” He added that although the market is euphoric, OPEC+ non-compliance will persist and even Saudi Arabia itself may not follow through on its promise.

Still, the reaction from the market was obvious. Crude prices shot up more than 5 percent, and the share prices for a broad set of oil and gas companies surged by similar percentages.

But even some in the U.S. oil industry worry that a rebound in U.S. shale, such as it is, could potentially head off a necessary correction. Even as data in the Dallas Fed survey showed signs of improvement, not all respondents to the survey saw an uptick in drilling as a positive development. “Drillers insisting on bringing rigs back and additional production online will continue to destroy investor dollars consistent with pre-pandemic negative returns, and as a result, accelerate the exodus of capital from our sector,” one anonymous executive said in the Dallas Fed survey. “Production needs to be allowed to go lower, and companies need to shift their business models to be more economic producers.”