Sorry it took this long

I am not really sure what direction the energy market is headed, especially the hydrocarbon segment which makes up almost 80% of current energy sources. One month you hear a politician saying “keep it in the ground” with an eye towards climate change and the next month another one asking the industry to increase production due to pain at the gas pump and inflation fears. One thing is clear is that this so-called Energy Transition will be a bumpy ride.

With high natural gas prices in Europe and oil nearing $100/Bbl., renewed importance on energy independence could weigh on policymakers' efforts to decrease the usage of fossil fuels, with coal imports to the EU in January climbing 56% from the prior year. The U.K. Coal Authority also recently allowed a mine in Wales to increase output by 40M tons over the next two decades, while Australia is planning to open or expand more coking coal mines. Over in the U.S., U.S. Energy Secretary Jennifer Granholm is urging American producers to raise their oil and gas output, even telling the National Petroleum Council in December to "get your rig count up."

The story of the North American shale revolution is an interesting tale of technology and ambition, determination and a little bit of luck. A lot is written about George Mitchell and his Mitchell Energy’s successful program to turn his leases in the Fort Worth Basin into the beginning of a resource revolution, that turned the global oil and natural industry on its head and forced OPEC+ to take notice.

George P. Mitchell turned hydraulic fracturing from an experimental technique into an energy-industry mainstay, making it possible to produce oil and gas from rocks once thought as only source rocks and unleashing an energy boom across the U.S. Known as the father of fracking, Mr. Mitchell died in 2013 at age 94 at his home in Galveston, Texas.

The co-founder of Mitchell Energy & Development Corp. spent years pushing his company's engineers to find ways to get more natural gas out of the ground. They finally figured out successful ways to break up shale rocks with pressurized water, chemicals and sand in the process known as hydraulic fracturing. "George Mitchell, more than anyone else, is responsible for the most important energy innovation of the 21st century," said Daniel Yergin, vice chairman of consulting firm IHS.

But Mitchell was only the start. During the middle part of the last decade, shale pioneers launched an industry bonanza that created energy independence in the US and a drilling and production boom that no one saw coming, especially OPEC. But it came at a cost. To keep the rigs running and the crude oil and natural gas flowing, it took a lot of investor capital. Companies began, flourished and then crashed on the dynamic market fundamentals of supply and demand over the last decade and a lot of jobs were created and destroyed in less than ten years. That is a pretty short energy spike for engineering students trying to plan for a career. Early in 2020, it looked like the revolution was over when the Covid pandemic nearly shut down the world’s economy, but commodity prices have recovered and geopolitical concerns are pushing them higher, but many of the shale pioneers are behaving differently this time.

Scott Sheffield was one of those ambitious pioneers as co-founder of Pioneer Natural Resources. Now at age 69, he looks at the industry from his Lightning Fork Ranch in New Mexico and is leading a new approach, one of capital discipline. Mr. Sheffield retired from Pioneer in 2016 to his ranch. In 2019 he returned to Pioneer convinced of two new realities. One was the industry’s tendency to produce too much oil, even when it was unprofitable and the other was the growing sense that demand for fossil fuels might peak in the coming decades. He became convinced that the shale revolution needed to reinvent itself. It is ironic that just when climate change is making investing in fossil fuels unfashionable, the shale industry is finally becoming investible. (Keeping it in the ground, The Economist, July 10, 2021)

Capital Discipline, Production Restraint and Consolidation with an eye on environmental impact

With less investment and a slower pace of drilling, as well as higher prices per barrel and per MCF, the shale pioneers are now returning cash (and a lot of it) back to investors. Rystad predicts that American shale industry will generate almost US$350bn in free cashflow in 2021. Much of that will go to shareholders not new drilling rigs, despite Ms. Granholm’s plea.  Share prices are responding accordingly. Consolidation with mergers and acquisitions are helping to cut costs and act as another barrier to oversupply. Stronger producers are also committing to reduce flaring and methane leaks, plugging abandoned wells and making public targets about their climate change ambitions.

Goldman analysts said U.S. producers again would likely signal they are still capital disciplined, “not only through the rest of this year, but also in 2022.” Even with a 20% average increase in capital expenditures (capex) year/year by the U.S. producers, frugality remains the message. “We do not believe that public E&Ps are likely to diverge from this dynamic, especially following years of investor criticism for outspending cash flows and not returning cash to shareholders.” A few major Permian Basin producers have nudged up their production plans, like ExxonMobil and Chevron, but most are sticking to their more conservative goals.

For the first time this year some investors are shifting their preferences to natural gas E&Ps over oil-directed producers. That’s because the analysts are modeling “higher potential payout capacity and believe there is greater near-term upside in Henry Hub.” When was the last time that happened?

The Wells Fargo equity analyst team said, “Shale 3.0 has arrived,” across the E&P sector, with quality and efficiencies now driving earnings results.  “Accelerated by a global pandemic, a majority of E&P operators have been increasingly adopting our Shale 3.0 framework,” which preaches moderate growth and free cash flow (FCF) generation.

https://www.naturalgasintel.com/eps-to-repeat-capital-discipline-mantra-in-2q-results-but-ofs-may-signal-price-increases/

But recently there are new signals of production increases from of all places the White House. President Joe Biden, who has asked OPEC+ to raise oil production faster to tame runaway energy prices, just got a gift on his home turf instead: a blockbuster growth forecast for U.S. shale production from the country’s two biggest oil companies. Supply and demand are one thing but so too are geopolitical factors.

Exxon Mobil Corp. plans to boost output by 25% this year in the Permian Basin, the biggest U.S. oil-producing region. That comes days after Chevron announced it will ramp up its own Permian supplies by 10%, from an even larger production base. Such aggressive targets from the Western world’s largest oil majors are a surefire sign that U.S. shale is back to growth mode after cuts in 2020 and a lackluster 2021.

With oil trading near its highest since 2014 and inflation raging across developed-world economies, extra supply from the U.S. — or anywhere else for that matter — would be welcomed by the Biden administration, especially now with the uncertainty in the Ukraine. But resurgent domestic output brings its own dangers. Recent history has shown that too much shale production can quickly overwhelm worldwide demand. It also risks upsetting members Organization of the Petroleum Exporting Countries and the group’s allies, who have crashed the market twice in the past eight years through damaging price wars in response to U.S. shale growth.

But the U.S. majors don’t think their Permian expansion plans buck the production discipline trend that’s become a mantra among energy investors. That’s because much of their growth in the U.S. will be offset by naturally declining fields elsewhere in their global portfolios. Independent operators, by contrast, don’t have such offsets, meaning their growing supply flows directly into the market.

So, are these good times for the oil patch or not? I guess if you have deep pockets (financially speaking) there are some reasons to be hopeful. If you have to go to the bank for money for your next drilling program, maybe the conversation is different. The oil and gas industry has always been an interesting place, it is not any different now.

Scott Sheffield and his peers are still optimistic about the shale industry in North America. He believes the industry has finally found a business model that works. He told the Economist that “I’m sorry it took us this long.” Maybe there is something to this Shale 3.0. Let’s keep our fingers crossed.