If Breaking Up is Hard to Do, Try Not Growing Oil
Someone had to do it, and it might as well have been one of the biggest names in US shale.
Having whittled its 2015 capital budget down to $5 billion, 40% lower than last year, US producer EOG Resources last week made the tough call of forfeiting production growth this year, saying it would drill but not complete wells in a low oil price environment.
That is in contrast to many oil companies which are similarly cutting capex by sizeable double-digits but assuring the market they can grow production, 5%, 10% or even 20% or more this year while on a fiscal diet.
While that is ordinarily something to be proud of, and reassures Wall Street and corporate shareholders, the drawback is that further production growth isn’t the cure: it’s the problem.
Low oil prices that have fallen by more than half their mid-2014 highs of over $100/barrel reflect an oversupply of crude that increasingly keeps gushing from US shale wells. Listen to almost any quarterly conference call or presentation, and managers will relate how they have increased oil yields per well over time.
Under normal circumstances, the higher volumes would be considered just reward for the expensive and Herculean effort of oil extraction. And for the last few years, it has been. But lately, those fertile wells have turned out more crude than the US can use.
And since the US exports oil only in very limited cases, oil has been mounting in storage bins, inadvertently holding down oil prices.
Producers are highly aware of all this. But it’s a sort of NIMBY-like phenomenon, only instead of “Not In My Back Yard,” it’s more like NIMOF—”Not In My Oil Field.” That is, no one wants to not grow production when every impulse – and the market – urges them to do so.
Yet EOG, one of the largest producers of US unconventional resources and a major force in all the major domestic plays, said it expects to complete about 45% fewer wells compared to last year, and so will keep this year’s crude oil production roughly flat year-over-year, while both natural gas and total company production should decline “modestly.”
That is in marked contrast to 2014, when the company’s crude oil grew 31% year-over-year to about 289,000 b/d and total company production grew 17% to 595,000 b/d of oil equivalent.
In releasing fourth-quarter results, Bill Thomas, EOG’s CEO, said the company is “not interested” in accelerating crude oil production in an environment that has seen oil prices stubbornly hover around $50/b in recent weeks.
Instead, EOG will drill but not complete roughly 85 wells or so in 2015, on top of its existing 200-well backlog that it began the year with. That will save money on completion costs, which amount to as much as 70% of total well costs.
Credit Suisse analyst Jim Wicklund noted that usually the first few who opt to concede growth see their stock prices, and net worth, reduced “significantly.”
“No one wants to be first,” Wicklund said last week in an investor note applauding EOG’s move. “So EOG, publicly acknowledging the issue, takes the step to address it. Cut production growth to zero until the problem is fixed.”
Having drilled wells that are ready to be completed at the right time gives the company a potential jump on production going into 2016, when oil prices are widely expected to recover to $65-$70/b.
Also, the wells that are drilled this year will be cheaper, as will completions when that happens, since oilfield service costs are widely expected to drop by 10%, 20% or more this year as producers petition discounts from suppliers, including drillers.
EOG is both vocal and adamant about its willingness not to grow production this year, but it isn’t the only company to defer completions. Apache will defer a couple of hundred wells, Chesapeake Energy about 100 wells, and Continental Resources will defer 25% of its Q1 completions in the Bakken Shale. Others are also deferring wells to some degree.
But Barclays analyst Tom Driscoll said in a recent report that EOG’s strategy of deferring new well completions until next year differs “markedly” than other companies, in that it will keep production “U”-shaped this year.
“EOG could complete 35-60% more wells in 2016 vs. 2015 off a capital plan that is only 25% higher,” he said.
Initially, EOG was penalized for its contrarianism; its shares dropped as much as 9% after the stock market opened last Thursday, a day after EOG unveiled its plan. Over the day the market reconsidered, and the shares closed the day down just 1.6%.
“That is leadership,” Wicklund said. “Making hard decisions for the longer-term greater good of the industry and the company, even if unpopular in the short term. It is one of the more bullish things we have seen.”
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