Rystad Energy: Shale Newsletter - March 2021 - eng

US shale targets flat 2021 capex, switches from earlier talk of cuts as prices rise

US tight oil producers reported strong fourth-quarter earnings, confirming our expectations of the industry sticking with its commitment of maintaining balanced operations even amid a recovering oil market that made drilling economics much more favorable across most regions compared to a few months earlier. It is evident by looking deeper into the industry’s spending plans that most of the efficiencies achieved in 2020 are set to not just rollover into this year, but producers are expected to build on those gains to take them to new record highs. While current fracking activities are being supported by the unusually high inventory of drilled but uncompleted (DUC) wells, and many operators have already added rigs back to levels needed for a smooth transition from DUC-driven completions to normal operations from the second and third quarters of the year, the updated guidance suggests that the industry is considering incremental activity boost in the new price environment, which may allow them to step into 2022 with a larger operational well inventory. Factors that drove the drastic reduction in costs per barrel in 2020 include reduced services spending, partly on account of price deflation for completion components, continuous high grading of operations, maturity in base decline rates, in addition to the large accumulation of DUC wells. But most importantly, operators continue to focus on balanced spending and free cash flow at levels they have never done before.

The flat industry-wide capex for oil operators translates to a guided 2.4% decline in oil production in 2021 versus 2020, or about 100,000 barrels per day, with fourth-quarter volumes holding nearly flat to a year earlier. There are many factors at play here that will blunt guided 2021 output, including frigid weather conditions in Texas taking large volumes of production offline last month.

Even before the freeze, production and activity levels for the year were expected to be backloaded. That was driven by seasonal factors and as operators were reluctant to make spending commitments in a volatile market, refraining from providing strong growth targets amid price and regulatory uncertainties. For operators that did provide 4Q21 estimates, they uniformly moved higher. Conversely, oil production is expected to decline by 7% from 4Q20 to 1Q21 across a group of 14 operators that offered guidance for the quarter. They include several not operating in the Permian.

Within the peer group*, individual operator strategies vary, even among companies in the same basin or of the same size. Some will focus on meeting their FCF targets in order to reduce debt and boost shareholder returns through increased dividends and buybacks, while others see the stronger market as an opportunity to re-invest cash to grow production at higher prices. Aside from capital discipline, the question remains as to whether extra US tight oil barrels are needed in a market that is looking increasingly tight, especially as the OPEC+ meeting nears. As OPEC+ members debate whether to roll back some of curbs on production, with the price of WTI now over $60 per barrel, an influx of US supply from producers seeking to capitalize on generating FCF while still growing production at higher prices could in turn weigh on the market’s outlook.

Multi-play producers lead the way in absolute projected oil production growth in 2021, adding 11,600 bpd in oil volumes in 2021.

Figure 3 illustrates the industry-wide change in capex from 2020 to 2021 by basin, with the level holding relatively flat, with a decline of only -0.80%, or $283 million, for both oil and gas-focused operators.

Overall, based on the current budgets we do foresee a strong possibility of production beating guidance in 2021, with a solid upside in volumes in the later part of the year.

US tight oil maintains 55% reinvestment rate in 4Q20 on capex, CFO basis

The fourth quarter of 2020 showed an underspending of close to $3 billion by shale producers when comparing their capex to cash from operations. Operators managed to further reduce their capex from the lows seen in the previous quarter, to $3.6 billion from $3.9 billion, while also making slightly lower cash from operating activities, at $6.6 billion. The number of operators that balanced their spending in 4Q20 reached 90%, a level never previously recorded in the history of US shale. The spread reached $3 billion – a second all-time high slot just after the first in the third quarter.

Combined net losses for US shale oil producers in the fourth quarter narrowed to $4 billion versus $6 billion in the previous three months and from the plunge to $18 billion in the second quarter. EBITDA recovered to $7 billion from $6.5 billion in the previous quarter. A few operators reported additional impairments, while most displayed negative derivative net fair value change. Leading Permian operators as well as several diversified players saw their EBITDA increase by 20-30% in the final three months of the year compared to the quarter before, while the NYMEX forward strip recovered only by less than $3. The peer group reported the second-highest level of free cash flow in the shale industry’s history, at $2.8 billion followed by the peak of $3.5 billion in the previous three months. With that, there are five other reporting quarters when the accumulated FCF for the group was positive.

The steep decline in the NYMEX strip pushed operators to adjust their economically recoverable proved oil and natural gas reserves and report impairment charges, which only slightly continued into the fourth quarter. The adjustment on a company level depended on the new price strip assumed by the producer as well the productivity and economics of its inventory.

Net fair value changes recognized for hedges and derivative financial instruments in 4Q20 amounted to a negative $1.7 billion, which is a slight downward revision from the negative $1.6 billion reported in the previous three months. The calculation is based on the gain on derivatives, adjusted by net settlements received from derivatives.

Dividend payments jumped by more than 10% for the peer group in the fourth quarter, while the actual dividend-to-capex ratio jumped to 19% compared to 17% in the previous quarter. A further reduction in capital spending by the industry has partly helped in targeting stable shareholder support, with stock prices recovering by 30-50% in the fourth quarter.

Similar to the second and third quarters, stock buybacks predominantly remain paused as companies await signs of a structural recovery in commodity prices. Stock repurchases increased by 85%, or $53 million, in the fourth quarter from the previous three months for shale E&Ps, now accounting for 3% of their quarterly capex.

*Rystad Energy’s analysis covers a peer group comprising of the top 39 public US tight oil producers, excluding majors, gas companies and Anadarko. Due to mergers and bankruptcy filings, the group had shrunk to 35 by the fourth quarter of 2019 and to 28 in the third quarter of 2020. The current group of 28 shale producers accounts for 43% of the expected 2020 US tight oil output. Numbers are estimated for six micro-cap operators that are yet to report their earnings.