U.S. oil production dipped by 61,000 barrels daily in May, the EIA reported this week, confirming what many already expected: continued stringent discipline among drillers. But those expectations may have been misleading because now some producers are planning output boosts—thanks to cost reductions.
Last year, shale drillers surprised pretty much everyone by increasing their production considerably despite a drop in drilling rigs. The increase came thanks to improved drilling efficiencies that drove production costs down and output up. This year, the industry looks set to continue on that trajectory.
Wood Mackenzie analysts reported this week that costs in the shale patch could decline by 10% this year. The analysis sees costs peaking in 2023 and beginning to fall this year, with the decline set to continue—albeit at a much slower pace of 1%—in 2025.
“More efficient operations are helping E&Ps drill and complete wells faster, cutting costs. At the same time, OFS firms are utilizing more efficient kit and workflows to sustain elevated prices,” Wood Mac principal analyst Nathan Nemeth said. “If E&Ps look to reduce costs more, it must come from additional efficiency improvements, as OFS pricing is unlikely to fall.”
This is where Wood Mac could be wrong, however. Oilfield service providers are being forced to discount their services in a bid to get the business of a shrinking selection of clients amid the consolidation wave still riding high across the oil and gas industry in the U.S.
“When customers combine, you might have a guy who was running seven rigs, and a guy who was running five rigs, that adds together to 12. But when they come back, they run 10,” Chris Wright, chief executive of Liberty Energy, told Reuters in July.
“As consolidation occurs, often the acquiring company will not pick up the existing service companies. Once cut loose, these companies are searching for a lifeline and in many instances willing to work for negative margin rates, doing whatever they can to put money toward fixed period costs,” one industry executive told the Dallas Fed Energy Survey.
All this means that oilfield service providers would be ready to go even lower to survive—until they can’t go any lower, of course. But this is still positive for exploration and production companies because they get a bargain on their services, which contributes to their overall costs. And when costs are down, companies can afford to drill even in a lower price environment.
Bloomberg reported this week that several large shale producers had revised their production plans for the year. One of them, Civitas Resources, said the revision was a result of higher than expected well yields in the Permian. But there may be another reason for these revisions and that reason may be lower costs, which are making drilling economical under circumstances that it would not have been economical a year ago.
According to Wood Mackenzie, the rig count in the U.S. shale patch is set for an increase over the next year or so but this increase will not be as substantial as it might have been in past cycles due to the drilling efficiency gains. These, the research firm said, would eliminate the need for 28 rigs.
This is good news for exploration and production companies but not for rig operators. It looks like the bottom in oilfield service pricing discount is getting near, fast. This will prompt a consolidation in that segment of the industry as well, mirroring the recent developments in E&P territory for lack of any other viable options for long-term survival.
“Too many equipment providers are chasing too few E&P customers. Without consolidation within service or equipment providers, it will be a race to the bottom for pricing,” an industry executive told the Dallas Fed Energy Survey. Meanwhile, the space for cost cuts will begin to shrink.
According to Wood Mac, this year’s 10% improvement in shale costs will slow down to just 1% next year as oilfield service providers reach the end of their discount tether. “With stronger balance sheets, anticipated increases in activity levels, and high demand for their most efficient equipment, they will feel less need to concede,” Wood Mac analysts wrote.
As usual, the biggest players in both the E&P and the OFS fields will be the winners. They have the resources to withstand the current OFS situation and seal long-term service deals with the big E&Ps, which, in turn, have the resources to commit to such deals to mutual benefit. The consolidation spree in the shale patch will eventually end, leaving maybe a lot fewer companies both in production and in servicing. That would slow down efficiency gain momentum—for a while, probably, as the industry gets used to its new, leaner and meaner, state before embarking on the road to the next level of efficiency gains and cost cuts.
