Commodities Corner: Why surging oil prices don’t always mean big profits for U.S. shale producers

U.S. shale oil producers don’t benefit quite as much as you might expect from high crude prices, thanks to pipeline bottlenecks and price hedging.

“Many of these shale companies are spending more than they are making, or close to it,” said Matt Badiali, senior research analyst at Banyan Hill.

“These companies aren’t exposed to the higher prices because many of them hedged their oil production at $50 per barrel,” he said—well below the $62.88 he pegged as the average in the first quarter of this year.

Opinion: Two ways to play oil stocks while limiting your risk

Prices have climbed even further since then. On the New York Mercantile Exchange, U.S. benchmark West Texas Intermediate crude for June delivery CLM8, +0.13%  settled at $71.49 a barrel on Wednesday—the highest since November 2014. Futures prices have climbed by nearly 19% year to date.

Read Opinion: These U.S. shale-oil companies are poised to profit when prices rise

But that rise in prices put companies who hedged against the potential of falling oil prices at a disadvantage.

WPX Energy Inc. WPX, +1.64% for example, reported an adjusted net loss of $30 million for the first quarter, driven by $69 million of net losses associated with its hedges.

Per-barrel profit

Figuring out the break-even cost per barrel for shale oil producers is a bit tricky, though experts agree that it runs lower than current futures prices.

Jerry Bailey, president of Petroteq Energy Inc., said the cost of oil production from shale is in the range of $30 to $50 a barrel for most companies. “When WTI is at $70 and assuming the sales are close to that figure, there is still a healthy profit margin.”

But the production cost per barrel for shale drillers can differ depending on a number of factors.

‘No two holes in the ground are created equal. Breakeven costs can vary wildly among shale producers.’

Denton Cinquegrana, OPIS

“No two holes in the ground are created equal,” said Denton Cinquegrana, chief oil analyst at the Oil Price Information Service. “Breakeven costs can vary wildly among shale producers.”

He pointed out that one of the bigger issues lately among shale producers has been “takeaway capacity.”

“Growth in production has outstripped pipeline capacity to move barrels to the Gulf Coast refining centers or Corpus Christi export terminals,” Cinquegrana said. “As a result, the price you see on the screen is not anywhere near the price based on local transactions.”

Over the past couple of weeks, WTI crude at Midland, Texas, which is part of the Permian Basin, has been running roughly $10 to $13 a barrel below WTI futures prices, so prices there are at barely $60, he says. This is among the reasons why the market has seen the WTI-Brent spread “blow out of late.” Brent currently trades more than $8 higher than WTI—the biggest spread in about three years.

Read: Here’s why U.S. oil is trading at its biggest discount to the global crude benchmark since 2015

Badiali said that Permian Basin oil is selling at the steepest discount to benchmark U.S. prices in 3½ years, after production there surged to a record of around 3.2 million barrels a day.

“That means even the big operators aren’t seeing the benefits of higher prices yet. That will change as these companies get out of, or improve, their hedges,” he says.

Rising investment costs and inflation

U.S. shale producers have also increased their investments as prices for oil climbed, said James Williams, energy economist at WTRG Economics.

Drilling in the Bakken, which covers parts of Montana and North Dakota as well as parts of Canada, has climbed by 28% over last year and in the Permian, which covers parts of western Texas and southeastern New Mexico, it’s up 31%, according to Williams.

For 2017, U.S. shale oil production was estimated at 4.67 million barrels a day—representing about half of total domestic crude production, according to a monthly short-term energy outlook from the Energy Information Administration.

Separately, an EIA monthly report on drilling activity estimated oil output from seven major U.S. shale plays at 7.034 million barrels a day in May. It’s expected to climb to a record 7.178 million barrels a day in June.

Shale oil producers “are just not generating enough cash to fund all of their investment in new wells,” so the remainder comes from investors and borrowing, said Williams. “But the cash flows in over time, after you spend the money on drilling the well.”

Inflation is another important factor. When oil prices were falling in 2014 and 2015, both staff and drilling costs fell sharply, but this “trend has since reversed as the market has tightened considerably and heavy cost inflation has returned,” said Matthew Parry, head of long-term research at Energy Aspects.

He estimates that the U.S. shale oil industry is “probably dealing with these rising costs more than most, and wouldn’t be at all surprised if their cost inflation tests 20% in 2018.” That would “pull back a lot of the returns that would otherwise have been garnered at today’s plus-$70 WTI price level.”

Time for catch up

That said, shale producers can boost production levels fairly quickly.

Cinquegrana estimates that it takes about seven months to bring shale production online, while deep water Gulf of Mexico output can take seven years to ramp up.

“Suffice to say as prices rise, onshore production can too,” he said.

Looking ahead, it looks as though shale oil producers may have the time they need to catch up.

Bailey expects the $70 level for WTI to be “sustained through the summer and perhaps see a rise of several dollars,” given turmoil in the Middle East.

Saudi Arabia is likely to “backfill” most of any production declines stemming from Iran, he said, following the U.S. withdrawal from the nuclear deal with Tehran, adding that the Saudis are likely satisfied with the $70 price range so that price level is likely to be maintained in the coming months.

But Badiali has loftier prices expectations. He expects lower output from Venezuela to continue to tighten the market, and “sanctions on Iran and trouble in the Middle East will heighten anxiety and increase volatility of oil prices.”

The average WTI oil price is likely to move higher, “with spikes on bad news that could send the price over $100 over the next 12 to 18 months,” said Badiali.

Filed in: Top News Tags: 

You might like:

Vitaliy Katsenelson's Contrarian Edge: Investors have misdiagnosed Amazon’s push into the pharmacy business Vitaliy Katsenelson's Contrarian Edge: Investors have misdiagnosed Amazon’s push into the pharmacy business
London Markets: London markets higher, buoyed by materials stocks, trade optimism London Markets: London markets higher, buoyed by materials stocks, trade optimism
Next Avenue: Consider this investment strategy to generate income in retirement Next Avenue: Consider this investment strategy to generate income in retirement
NerdWallet: How to retire in your 30s or 40s—even if you have kids NerdWallet: How to retire in your 30s or 40s—even if you have kids
FA Center: Find financial advisers who can give your portfolio a personal touch FA Center: Find financial advisers who can give your portfolio a personal touch
Catholics skip the collection plate amid ‘moral catastrophe’ of Pennsylvania’s sex abuse cover-up Catholics skip the collection plate amid ‘moral catastrophe’ of Pennsylvania’s sex abuse cover-up
Outside the Box: How a CEO’s personal habits can cost you money Outside the Box: How a CEO’s personal habits can cost you money
Grow: How to handle a financial emergency, even if you’re living hand to mouth Grow: How to handle a financial emergency, even if you’re living hand to mouth

Leave a Reply

Submit Comment
© 2018 Stock Investors News. All rights reserved. XHTML / CSS Valid.