MACROSCOPE
Macroscope
by

US shale drillers struggle amid slumping prices

PUBLISHED : Tuesday, 11 August, 2015, 9:17am
UPDATED : Tuesday, 11 August, 2015, 9:17am

North America’s shale drillers are struggling with the renewed slump in oil prices, despite cutting costs, boosting output, and in some cases employing hedging to improve realised prices.

Stock prices for most of the main shale drillers have fallen faster than the price of US light crude since the middle of April.

Spot WTI has fallen 20 per cent since mid-April but the share price of Pioneer Natural Resources has dropped 30 per cent and Continental Resources is down almost 40 per cent over the same period.

Both companies increased production during the second quarter. Pioneer produced 197,000 barrels of oil equivalent per day (boepd) in April-June, up from 194,000 in January-March, while Continental reported output of 227,000 boepd, up from 207,000.

Pioneer’s production is mostly from the Permian Basin and Eagle Ford in Texas, while Continental’s operations focus on North Dakota’s Bakken and Oklahoma.

Both companies reported that drilling and completion costs had fallen by 20-25 per cent compared with the end of 2014, they told analysts during conference calls held in the first week of August to discuss their earnings.

Both companies are drilling wells faster than ever before, in the best case in just 13 days, which means they can squeeze out extra efficiencies by drilling the same number of wells with fewer rigs, or more wells with the same number of rigs.

Both are speeding up drilling time and boosting output per well by focusing on the most prolific shale layers in the most productive areas.

Both expect to grow their production this year compared with 2014, by 10 per cent in Pioneer’s case and 19-23 per cent for Continental.

Yet neither company made money in the second quarter. Continental’s net income was basically zero while Pioneer posted a net loss of US$218 million.

In some ways, the two companies have opposite philosophies and strategies: the fact both are struggling to cope with the renewed slump in prices illustrates the challenge all shale firms face and the lack of good options.

Pioneer points to its active hedging programme as a key source of competitive advantage that will enable it to weather the slump better than its rivals.

Pioneer has hedged 90 per cent of its forecast 2015 oil production at an average price of $71 per barrel, and the company has already established three-way collars to protect around 75 percent of its forecast 2016 oil production.

By contrast, Continental lifted its 2015 hedges in October 2014, realising a profit at the time, but gambling on a rebound in oil prices which has not happened and leaving the company exposed to full extent of falling prices.

But the biggest difference lies in their attitude to prioritising production growth versus capital discipline in the face of lower oil prices.

Pioneer has repeatedly emphasised its determination to continue growing its output aggressively even if wellhead prices remain below $50 per barrel.

The company confirmed its plan to add two extra drilling rigs per month during the second half of 2015 and eight more in the first quarter of 2016.

Pioneer is targeting compound annual growth in oil production of more than 20 per cent between 2016 and 2018 even if prices remain in line with the current futures curve.

Repeatedly quizzed by analysts about whether the company was targeting production or returns, the company insisted its wells were highly profitable even at current prices, so it wanted to drill as many of them as possible.

"Why don’t you pursue more of a return strategy than a growth strategy?" one analyst wondered. But the company disputed the distinction and insisted it was maximising returns by growing volume profitably.

Faster drilling, cost reductions and hedging will enable the company to meet its production targets despite lower prices.

The difference between Pioneer and Continental is one of emphasis as much as strategy, profitable growth versus cutting capital spending while maintaining output.

But the fact that both companies have seen their share prices pummelled over the last four months highlights the awkward position in which all shale producers are stuck. Recent price falls have eliminated the advantage they have wrought from cheaper costs and faster drilling.

The shale sector’s problem resembles the difficulties which airlines had until recently, growing capacity without making a profit. The airlines eventually learned to prioritise profits over capacity, but only after years of pain. The shale sector appears to be at the start of a similar learning curve.