Analysis: Shale's growing profits at the mercy of OPEC cuts, Trump tweets

Abraxas Petroleum

05/12/2018 12:24

By Jennifer Hiller
    HOUSTON, Dec 5 (Reuters) - The recent nosedive in crude
prices came just as shale producers had started delivering
healthy returns after years of heavy spending to boost
production and market share.
    The shift has pleased investors who had grown weary of
waiting for a payoff while watching the frenetic west Texas
shale boom make the United States the world's top oil producer
and a major exporter.
    The 29 percent drop in U.S. oil prices since October now
threatens those improved margins, and sustained prices below $50
could dent the value of shale reserves, which banks use to
determine borrowing power. 
    Activity in the largest U.S. oil field could fall 10 to 20
percent next year if prices stay down, said Steven Pruett, chief
executive of shale producer Elevation Resources LLC. The price
retreat sparked a sell-off of shale firms' shares and another
setback could sour investors on the sector for years.
    The dynamic leaves shale producers hoping for a rescue in
the form of production cuts from The Organization of the
Petroleum Producing Countries (OPEC) when it meets on Thursday -
and at odds with U.S. President Donald Trump, who has pushed
OPEC to keep the taps wide open.
    Although Trump has generally been a boisterous booster of
fossil-fuel firms, he has ridiculed the prospect of OPEC
production cuts as "ripping off the rest of the world" by
artifically inflating consumer fuel prices.
    In November, Trump praised Saudi Arabia on Twitter for high
production that helped push oil prices down about 30 percent to
near $50, calling it "like a big Tax Cut."
    Such tweets are an "irritant" to a U.S. oil industry trying
to solidify its profitable position.
    Trump's "leaning on" Saudi Arabia, the most influential OPEC
nation, "has had a great effect," Pruett said.
    "To me, it's a lot of meddling," he said.  
    Trump's campaign against OPEC cuts comes after he stood by
the kingdom and Saudi Crown Prince Mohammed bin Salman despite
U.S. politicians calling for sanctions over the October killing
of journalist Jamal Khashoggi at Riyadh's consulate in Istanbul.
Prince Salman wants to avoid confrontation with Trump, Saudi
watchers say, including over oil production cuts and prices.
 urn:newsml:reuters.com:*:nL8N1Y11UZ
    While shale producers have made strides in recent years at
turning profits with lower oil prices, they are nearing a
threshold where some would scale back investment, said Phil
Flynn, an analyst at Price Futures Group in Chicago.
    "The reality is a lot of them get scared at $50, and their
bankers get scared at $50," said Flynn. "They want OPEC to make
a cut, and they kind of want Donald Trump to stop tweeting about
oil." 
    U.S. oil production will rise 17 percent this year to
average daily output of 10.9 million bpd, and hit 12.06 million
bpd by mid 2019, according to U.S. government estimates. After
years of increasing capital spending, companies including
Anadarko Petroleum Corp  APC.N  plan to freeze or cut those
budgets, passing the savings to investors.  urn:newsml:reuters.com:*:nL2N1XH17D 
    Even if OPEC pulls back and global prices stabilize at
current levels, it may not be enough for shale to regain
investor favor, said Bruce Campbell, president of advisers
Campbell, Lee & Ross Investment Management Inc. The firm owns
Royal Dutch Shell shares because of its strong dividend and
balance sheet, but no longer sees a reason to invest in shale.
    Shale companies can cut costs further, "but it takes 12 to
18 months to roll through the system" and get profits rising
again, he said. Without higher crude prices, it will be tough
for investors "to find a place to get excited about," Campbell
said.
    
    SHALE RESILIENCE 
    Since the 2014-2016 price war between OPEC and shale
producers - when soaring global supply pushed per-barrel prices
down into the $20s - west Texas shale drillers have learned to
wring profits at prices as low as $38 a barrel, down from about
$71 in 2014, according to consultancy Rystad Energy. 
    But breakeven prices in other U.S. fields range from about
$43 to $48 per barrel, not far from November's low.
    Meanwhile, Middle East producers' costs are about $11 a
barrel in Iraq, less than $17 in Saudi Arabia, and less than $21
in Kuwait, according to Rystad. 
    These countries, however, need much higher prices to finance
their state spending. In Saudi Arabia, crude would have to
average $85-87 a barrel to cover this year's state budget, an
International Monetary Fund official said.  urn:newsml:reuters.com:*:nL8N1S824M 
    The U.S. industry is still expanding the use of more
efficient drilling techniques, and oil majors' BP Plc  BP.L ,
Chevron Corp  CVX.N , and Exxon Mobil Corp  XOM.N  are expanding
shale operations and building pipeline infrastructure to keep
production rising. 
    “Shale is a scale business,” said Shawn Reynolds, a
portfolio manager at investment firm VanEck. 
    He sees an industry just now poised to move out of its
costly development phase and into what Reynolds calls "harvest
mode," pulling profit from past investments. 
    But a continued price decline would threaten recent robust
earnings. Last quarter, ConocoPhillips  COP.N  profit rose
four-fold over a year earlier aided by cost cuts that
"significantly improved our resilience to low prices," Chief
Executive Ryan Lance said during an earnings call last month. 
    Anadarko  APC.N  swung to a profit and said it expects to
increase production 10 percent to 14 percent next year, assuming
"$50 oil,” said CEO Al Walker.
    Other producers are counting on a replay of 2016, when OPEC
cut output and prices gradually increased.  
    "I've been through it before," Bob Watson, CEO of Texas
shale producer Abraxas Petroleum Corp  AXAS.O , said in an
interview. He has told his employees not to worry about the
price: "It will come back. You just need to keep executing." 
    Watson, like other large shale companies, used financial
derivatives to lock in some of its future production at $56 a
barrel, a move that lets it ride out the recent drop barring a
sustained change. 
    
    LESSONS FROM THE PRICE WAR 
    Non-OPEC oil output will rise by 2.3 million bpd this year
while oil demand should grow by a 1.3 million bpd next year,
projects the International Energy Agency, which advises major
oil consumers on energy policy. That could lead again to a
market awash in oil, lowering global prices.    
    OPEC this week must decide whether the global economy will
need more oil or less. After months of producing well below the
group's target, group leaders increased production last summer
and by October had added nearly 400,000 barrels per day over
September. Russia also increased its production by about 460,000
bpd above its cap.  urn:newsml:reuters.com:*:nL8N1XQ0R4 
    "OPEC realizes that in the last downturn, in an effort to
grab market share, they got nowhere. They ended up losing market
share to some extent," said Muqsit Ashraf, senior managing
director for energy at consultancy Accenture Strategy.
    One lesson from the last price war is shale can expand
production even at prices that hurt OPEC members' budgets, said
Karr Ingham, a Texas oil and gas economist.  
    Companies in the Permian Basin pumped 1.6 million bpd in
June 2014 when prices peaked at $107 and output rose to nearly 2
million bpd two years later as prices fell to $26, according to
data from the U.S. Energy Information Administration. 
    "OPEC can wait from now until kingdom come, but they won't
get … a production decline" from the Permian field, Ingham said.

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Break-even costs for producing oil in major U.S. shale basins   
  https://tmsnrt.rs/2QqA96E
What it costs Middle East oil producers to produce a barrel     
https://tmsnrt.rs/2DSOOki
 
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 (Reporting by Jennifer Hiller
Editing by Gary McWilliams and Brian Thevenot)
 ((Jennifer.Hiller@thomsonreuters.com; +1 713-210-8538;))