What if Oil Stays Around $100 but That Never Triggers a Boom?

High prices have predictably led to production booms that end in busts. But in this cycle, the focus has shifted from production growth to cash flow growth.

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Even record profits that have made the oil sector the top-performing sector in the US stock market have not inspired a return to capital expenditure levels that are anywhere near the historical average.
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Oil and gas is one of the only business sectors that is profiting from the oil price surge to $100/bbl, but they are spending like oil is still at $50/bbl.

The US industry is growing, but far below the levels back when the pace of growth was so rapid, it was driving down global oil prices.

US producers are only expected to increase their production by about 600,000 B/D this year, and by an expected 700,000 B/D next year, said Helen Currie, chief economist for ConocoPhillips. She was one of the panelists who made the case for oil and gas production growth being lower for longer at the recent conference, “Energy and the Economy: The New Energy Landscape,” put on by the Federal Reserve Bank of Dallas and the Federal Reserve Bank Kansas City.

Those predictions, which are at the low end of projections, could be story-changing for oil writers who have always been able to assume that oil booms will follow a predictable plot line. It goes something like this: Tight supplies push up prices sharply. Industry leaders talk about getting this boom right by not rushing to add production and triggering another bust. Then the story quotes some cynical observers accurately predicting that spending discipline will not last, and runaway spending will soon enough lead to excess production and a bust.

Speakers at the conference agreed that oil company executives are so focused on maximizing cash flow to pay down debts and reward investors that the more critical thing any speaker could offer was to suggest they may well be underspending.

Even record profits that have made the oil sector the top-performing sector in the US stock market—up 68% while every other category is down—have not inspired a return to capital expenditure (Capex) levels that are anywhere near the historical average.

“In 2007, 50% of the cash spent by companies was going into Capex. Recently, that has dropped to 22%, while debt repayment has risen from 7 to 19%,” said Mike Lister, managing director and group head for energy, power, and renewables at JPMorgan Chase.

At this rate, “the industry as a whole will be net debt zero,” he said.

That bit of financial jargon means that the average company will have enough cash on hand to pay off their debt, which is a strange thing to see in “one of the most capital-intensive industries in the world.”

Growth Limiters

For the largest companies, this is in part a product of spending more on alternatives, ranging from carbon capture to offshore wind. But for the great mass of independents, their business is finding and producing hydrocarbons.

The speakers offered multiple reasons for why the US producers are likely to stick with slow-growth strategies that treat the business as a cash cow. Those reasons do not include a lack of drillable rock.

Currie said the output is “not limited by the resource.” Companies are spending more on Capex, but much of that money has been absorbed by double-digit price increases for services and supplies, she said.

Cost inflation is due to fast-rising labor costs and tight supplies of key hardware, including drilling rigs and fracturing fleets. Limited supplies have allowed service companies to negotiate higher rates and longer-term contracts, and recapture profitable sidelines such as being the chemical supplier on jobs.

Currie said service companies are now committed to the same sort of capital discipline as their oil company customers.

Another limiter is pipeline capacity limits.

Gas production in the Marcellus is frozen until pipeline capacity is added. That is looking iffy due to stalled efforts by multiple projects to get the permits needed to build in the eastern US, said Ademiju Allen, a gas market analyst for Rystad.

One reason for high prices are supplies limited by pipeline capacity.

“We can generate profits at $2.00/Mcf, and we have Henry Hub prices at $6.00. We have the best market in the world, and we cannot touch it,” said Toby Rice, CEO of EQT. Adding takeaway capacity in the east may reduce prices, but it could also create demand by expanding gas markets and allowing the creation of a nearby LNG export facility.

Growth has continued in the Haynesville and the Permian which are suppliers for Gulf Coast gas liquefication facilities, but new pipelines are needed to maintain their growth.

In the Permian, supplies of gas have exceeded the takeaway capacity at times recently resulting in negative gas spot prices at the Waha Hub, which handles much of the flow out of the play. Allen said that could happen again at times this winter during low-demand periods. Looking ahead to 2023, he sees two pipeline projects coming on line in the Permian, adding 1.2 Bcf/D of capacity.

While the Permian is known as an oil play, the high percentage of higher-priced gas makes flaring gas to produce more oil an unpalatable option economically, as well as environmentally. This means gas pipeline growth is required to maintain oil production growth as well.

Higher Hurdles

The cost of financing is rising and will continue to do so as the Federal Reserve pushes up rates to slow rising prices, which has been blamed on increasing oil and gas prices, among other factors.

The cost of loans is up sharply as the result of a series of 0.75 percentage point increases made by the Federal Reserve to reach its targeted interest rate to reduce demand for goods, making it harder for sellers to raise prices. That has forced central banks around the world to follow a similar strategy to defend the value of their currency.

Like chemotherapy, this blunt therapy comes with nasty side effects—it can stop economic growth, leading to recessions. Oil demand and prices are tied to growth, adding to the arguments against budgets that assume rising demand for oil and gas.

OPEC+’s recent price agreement assumed as much, cutting its production quota by 2 million B/D to maintain prices in the range from $80 to $90/bbl, with periods of prices at $100/bbl or greater. The fact that the group is already producing 3 million B/D less than its previous agreement, suggests the group has a lot of members focused more on profits than growth.

The US inflation report released on the day of the conference showed some of the rate of price increases has slowed a bit.

At the conference, Esther George, president and CEO of the Federal Reserve Bank of Kansas City, said rate increases will continue because “inflation has not let up.” News reports since the conference predicted 0.5% increases ahead—which is not as high as the recent series of rate hikes, but still a stiff dose of medicine.

Fast-rising interest rates increase the investment return needed to win approval for spending on oil and gas development projects, making it harder to sell growth.

Even with all the hurdles that projects have to clear, Dan Pickering, chief investment officer for Pickering Energy Partners, said, “good projects are getting funded, and the industry is putting off a ton of money.”

He warned of the risk of companies being “overly tight-fisted.” He defined that as companies that are earning $16 million per year, and based on their Capex, they will still be earning $16 million per year 5 years from now.

On the other hand, he questioned whether the rush to spend on carbon reduction will lead to bad choices and hasty project development that will “run the risk of destroying capital.”

As for the oil business, he said, “You can mess up a boom if you pump in capital like a drunken sailor.” But in this slow growth business, “we are not there yet.”