Chronic Underinvestment Could Push Oil Prices Higher In 2022

Yves here. Those who care about climate change and the health of the environment will probably despair at the fracking booserism, given that shale gas projects are big methane emitters unless the developer incurs costs to reduce that sort of thing. And more generally, continued solid demand for oil is yet another reminder that advanced economies aren’t far enough along in weaning themselves off fossil fuels.

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Originally published at OilPrice

  • After the fracking revolution left the U.S. shale patch bleeding cash and deeply indebted. Wall Street ramped up pressure on companies to cut debt and boost shareholder value.
  • The U.S. shale industry has exercised incredible restraint during this year’s oil price rally.
  • Consequently, investment in new wells has crashed 60% since its peak in 2014, which could send oil prices higher in 2022.

Long-suffering Americans grappling with runaway inflation are finally enjoying some reprieve. After a relentless climb, prices at the pump have been heading south, with national average gas prices tumbling to a 10-week low of $3.28 a gallon, according to AAA. Fuel prices started leveling out after President Joe Biden announced on November 23 the biggest-ever release from the Strategic Petroleum Reserve, though experts have dismissed it as a mere band-aid. Whereas many people have placed the blame for high gas prices on the Biden administration, the real culprit has more to do with Wall Street than Pennsylvania Avenue.

The genesis of today’s high gas prices can be traced back to financial pressure on oil companies from a decade of devastating losses and poor shareholder returns that have forced them to dramatically alter their business models. For years, Wall Street has pressured oil and gas companies to cut capex, and shift their cash to financial goals like boosting dividends and buybacks, paying down debt, as well as decarbonization, after the fracking revolution left the U.S. shale patch bleeding cash and deeply indebted.

Consequently, investment in new wells has crashed 60% since its peak in 2014, causing U.S. crude oil production to plummet by more than 3 million barrels a day, or nearly 25%, just as the Covid virus hit, and then failed to recover with the economy.

No Drilling

With Wall Street breathing down its neck, U.S. shale is literally running on empty: according to the U.S. Energy Information Administration’s latest Drilling Productivity Report, the United States had 5,957 drilled but uncompleted wells (DUCs) in July 2021, the lowest for any month since November 2017 from nearly 8,900 at its 2019 peak. At this rate, shale producers will have to sharply ramp up the drilling of new wells just to maintain the current production clip.

The EIA says the sharp decline in DUCs in most major U.S. onshore oil-producing regions reflects more well completions and, at the same time, less new well drilling activity–proof that shale producers have been sticking to their pledge to drill less. Whereas the higher completion rate of more wells has been increasing oil production, especially in the Permian region, the completions have sharply lowered DUC inventories, which could sharply limit oil production growth in the United States in the coming months.

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

According to S&P Capital IQ data, 27 major oil makers tripled capital spending between 2004 and 2014 to $294 billion and then cut it to $111 billion by last year. Once old wells were capped, new ones haven’t been available to fill the production gap quickly. The question is how long the restraint by publicly traded oil companies will last. Capital spending is expected to clock in around $135 billion next year, good for a 21.6% Y/Y jump but still less than half 2014’s level.

Shareholder Returns

Other than severely limiting new drilling activity, U.S. shale has also been keeping its pledge to return more cash to shareholders in the form of dividends and share buybacks.

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

Meanwhile, oil and gas companies have spent a more modest $8 billion in share buybacks, though ExxonMobil ((NYSE:XOM)and Chevron (NYSE:CVX) have pledged to buy back as much as $20 billion of stock in the next two years. The energy sector has made robust share gains in the current year, which could explain the reluctance to spend too much on share repurchases.

The most important reason, however, why oil prices are likely to remain high in the coming year is OPEC discipline:

“You have a cartel that is traditionally as disciplined as Charlie Sheen’s drinking, and for the last year, they’ve been as disciplined as Olympic gymnasts,” Tom Kloza, president of Oil Price Information Service, has hilariously told CNBC.

Oil Shortage

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

Higher oil demand will put pressure on both OPEC and the U.S. shale industry to meet demand. But let’s not forget that numerous OPEC nations have already been struggling to add to output, while the U.S. shale industry has to deal with investor demands to hold the line on spending. So far, the U.S. shale industry has not responded to higher oil prices as they had done previously, with overall U.S. production averaged 11.2 million bpd in 2021 compared with a record of nearly 13 million bpd in late 2019. U.S. production is expected to only increase by 700,000 b/d in 2022 to 11.9 b/d, according to Rystad Energy’s senior vice-president of analysis, Claudio Galimberti.

Canada, Norway, Guyana, and Brazil could try to bridge the supply-demand gap, but several Wall Street punters are betting it will not be enough and oil prices will remain elevated.

In fact, Barclays has predicted that the WTI contract price will increase 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 Petroleum Reserve isn’t a sustainable way to bring down prices. Barclays says prices could go even higher than that forecast if COVID-19 outbreaks are minimized and thus allow demand to grow more than expected.

Goldman Sachs shares that bullish outlook and has predicted a Brent price of $85 per barrel by 2023 compared to the current $76.30.

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  1. Steve H.

    Tverberg, 2019.

    From this month:

    > This price is not high enough for producers to want to prepare more fields for drilling. As far as I can see, the price needs to be up in the range of $120 per barrel, and stay there for many years, for oil producers to consider putting major effort into developing more fields.

  2. Bob

    Are we sure this story is not a trial balloon or more likely a red herring ?

    Fracking is economically dubious from the beginning.

    The present driver for fracking is two fold –

    First to capture liquids from the fracked wells. This is oil which can be used for motive fuels.
    Second to capture a myriad of tax benefits.

    And of course this is an opportunity to raise fuel charges.

    A way out of this dilemma is to switch to natural gas for motor fuels.

    1. Solarjay

      Hi Bob.
      From 2017, about 65% of gas and 50% of US production is fracked. Probably higher now.

      As to LPG, it’s just not cost effective against traditional gas wells and pipelines. I think it was why the US was against the Nord 2 pipeline, so they could sell Europe LPG.

      1. Bob

        Sorry but CNG (compressed natural gas) not LPG (propane) IS competitive when compared to gasoline / diesel.

  3. PlutoniumKun

    This sort of whiplash boom and bust is pretty much what Peak Oil theorists were predicting on the ‘downslope’ of oil supply. It is inevitable that as a transition is made that there will be huge mismatches between the supply and demand of the commodity that is on the way out.

    The one thing that frackers are looking at is the huge demand in Europe for LNG to make up for its shortfalls – pretty much all available ships are on their way across the Atlantic. But it takes a long time to put the infrastructure in place for LNG so its questionable whether anyone will be willing to pay the billions required for possible demand in a few years.

    1. drumlin woodchuckles

      If Americans can block and delay or even prevent every possible LNG export platform development, that gas will be forced to remain here where it will keep the price for NG for power plants low enough to keep underpricing coal and hopefully exterminating thermal coal from existence within the US.

      That’s a good reason to obstruct and prevent LNG exporting.

    2. Susan the other

      It is hard to understand how we, our NG industry, thinks it can produce and transport LNG to the EU in sufficient quantity to offset an otherwise recession. Maybe it’s a preemptive move (or a fake-out) because it looks like we are planning an all-out war in Ukraine and along the Russian border from Poland to Romania. Nordstream 2 has been unstoppable so far. I’m assuming it is because the EU has only 2 choices: recession or Russian natgas.

  4. Ozz

    Oil porn. It simply overlooks the damage small oil companies do. They go bankrupt leaving locals governments to pay the cost of cleanup and shutdown. The bonds they put up are trivial. You won’t see oil price talk about the cost of abandoned wells. The damage is real but overlooked because we need more investment. The last article linked here at NC to Oil price talked about how investors were finally going to see a payback. Oh well it is entertaining to watch them tall about it. Imagine if Hubert Horan applied his analytical skills to the oil business? That would be fun, they possibly could be worse then Uber.

  5. Synoia

    I recall, dimly, that fracking was never profitable.

    Continental Resources was or is one of the largest fracking businesses, and I believe it has dismal finances.

    And a CEO stupid enough to marry the Company’s attorney, and later practice infidelity. One wonders what part of his anatomy is running his business.

    I recall when he moved his Office from Enia,OK to OK City and my question was instantly, “Who is the woman?” to a very shocked audience of a number of my daughters’ circle.

  6. EarlK

    Not the LNG racket again! So much methane is also bad for teh airs, so there is that too. What happened to the hydrogen revolution? Flying cars? Space Force to the rescue with a national solar power satellite network; I can’t believe trump didn’t think of it.

  7. Louis Fyne

    Also should be noted that the big unknown is how much can/will OPEC pump in 2022.

    Some oil analysts argue that OPEC can’t pump that much more even if it wanted to as domestic reserves have been overstated by various OPEC members.

    1. Susan the other

      That is a good point because it is almost unbelievable that OPEC and US frackers have the “discipline” not to pump. The thought occurred that an edict has gone down to the oil industry that if they do not make petroleum a sustainable resource governments will move in and nationalize them. (That would imply that all governments are in agreement on the future of the oil industry.) I’d actually like to see that. It’s the only long term solution to both control the use/price of oil, and conserve it long into the future.

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