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Why the shale recovery remains so sluggish

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One thing to start: oil and gas stocks had a bad day yesterday, with sharp falls across the board as crude prices retreated from recent highs. Renewable energy stocks did better.

Welcome to another Energy Source. Today’s first note takes another look at why shale producers aren’t responding to the high oil price of recent weeks with another drilling surge. Our second note is on Joe Biden’s pipeline headache.

Thanks for reading. Please get in touch at energy.source.

What are shale producers waiting for?

US oil prices are above $70, close to six-year highs — a clear incentive for shale drillers to fire up the rigs. The difference between break-even prices across the shale patch and the 12-month forward price of WTI is near a record high too, points out Morgan Stanley.

Yet the rig count is rising more slowly in this recovery than it did after the crash of 2014-15, even though this time around oil prices are higher too. On average, operators have added just over four rigs per week since the low-point in August. That number was almost eight during the same phase of the recovery in 2016.

What explains this lethargy? Thanks to all who responded to my query. Here are some explanations from ES readers and others I spoke to for this piece.

1. No one trusts the rally yet

Opec has propped up prices — but still has about 5m barrels a day of supply (more than the entire Permian Basin produces) to bring back online. That doesn’t include any Iranian and Venezuelans supplies that might be restored.

Last year’s price war is not a distant memory.

“There is the logical belief that Opec will move the price down to unattractive levels if shale production accelerates again,” said one Energy Source reader who didn’t want to be named.

Rick Muncrief, chief executive of Devon Energy, said he wanted to wait until global oil consumption had fully recovered before considering new supply growth. Devon will hold output flat this year and cap any increase at a maximum of 5 per cent in 2022.

Confidence will also take more time, said others.

Artem Abramov, head of shale research at Rystad Energy, said most operators made their budgets before prices had reached $70/b — and some of them had hedged lots of their production at much lower levels. “They are not seeing a full impact of $75 a barrel,” he said. Rystad says the shale patch will rack up a record-high $12bn hedging loss this year. 

2. Oilfield services, damaged in the crash, are still struggling

The bankruptcies and huge sackings in the oilfield services sector last year have left that segment of the business underpowered. Some companies report that they are unable to rehire workers.

“You could very quickly run out of capacity,” if demand picks up, said Helge Tveit, managing partner at EV Private Equity, which backs several services companies.

“What should happen is that [services] companies increase prices so they can pay more workers. But that’s not happening because of this nervousness,” he added.

There are other distortions. The cost of steel and other drilling inputs are up significantly, meaning some wells may not be as economically attractive as once thought, pointed out another industry observer who wrote into ES last week. 

3. Investors are holding operators to their capital discipline pledges

Shale’s history of poor returns and investors’ growing focus on environmental, social and governance performance — coming just as an energy transition begins to accelerate — have reduced the capital available to fossil fuel producers. Wall Street will not fund another drilling binge.

Fast growth would be punished by the market, said Bradley Williams, head of Elephant Oil & Gas, a private driller. “The institutional investor base would give them hell,” he said, with an instant “10-15 per cent fall” in equity prices.

Any change in behaviour “will have to originate from the investor”, said Alex Beeker, principal analyst in corporate research at Wood Mackenzie. 

Meanwhile, stock markets are rewarding companies that pay back debt and distribute profits to shareholders. It’s one reason why US oil and gas stocks have outperformed all other sectors in the S&P this year. 

Consolidation and more mergers will be the preferred method of gaining scale for big operators, said analysts. Not drilling.

“It is cheaper to buy barrels today than to find them, which is probably why Pioneer [Natural Resources] is adding reserves through acquisition instead of the drill bit,” said the head of one merchant bank (and ES reader). Pioneer, the Permian Basin’s largest producer, is but one of many companies to have taken part in a recent M&A wave.

All of these factors leave the Opec cartel — which meets later this week to decide whether to increase supply — in a good spot, said Martijn Rats, global oil strategist at Morgan Stanley.

“Historically, the trade off for Opec was: if you support prices in the short run, then non-Opec supply rises. It was price or market share. On this occasion, Opec can have both.” 

(Derek Brower)

Biden’s pipeline headache

Joe Biden is doing his best to walk a fine line between the climate activists who want him to scupper new pipeline projects and the oil industry, which insists the infrastructure is essential to the country’s energy security.

He has tried to placate activists. He intervened to kill Keystone XL, which would have brought heavy Canadian oil to Gulf Coast refineries. The result was a disgruntled industry (and a disgruntled Ottawa).

And he has tried to placate industry. On the expansion of Enbridge Line 5 — (more Canadian crude) and Dakota Access (which ships crude from North Dakota’s Bakken shale field) — he has looked the other way. Cue activist outrage.

But Biden’s inclination towards compromise won’t appease both sides. As the Fletcher School’s Amy Myers Jaffe put it to me: “Addressing it well probably means that everyone’s going to be unhappy.”

A few other takeaways from my reporting:

Why target pipelines?

The oil industry argues that campaigners have failed to make inroads in undermining either supply or demand for oil and gas and therefore find pipelines an easier target.

“What they do is they try to step on the hose in the middle and stop this country from building the infrastructure that it needs to continue to grow,” Mike Somers, chief executive of the American Petroleum Institute, said last year.

A pipeline is a more clear-cut target than scores of coal or gas-fired power plants.

“They can point to one single thing as a symbol,” John Stoody, vice-president at the Association of Oil Pipe Lines, told me. “It’s easy to understand. It’s a central focal point.”

Targeting pipelines has worked. The success and prominence of campaigns against Keystone XL (dead) and DAPL (future unclear) has spurred action against pipelines elsewhere. The Atlantic Coast natural gas pipeline out of West Virginia bit the dust last year after a protracted legal battle.

Other movements — like the Stop Fracking campaign — “didn’t have the momentum and the national coverage of these pipeline projects”, said Jaffe.

“And so that caused, I think, people at local level to consider pipelines that were going through their neighbourhood . . . so you got this more localised activism.”

But how bad are pipelines?

The industry insists that there is no cleaner way to move hydrocarbons than by pipe. Shipping oil by rail or road involves much more CO2.

“That’s an inconvenient truth that the current administration and like-minded people don’t want to admit — that pipelines actually result in the least amount of greenhouse gas emissions admitted to deliver that energy,” said Stoody.

Indeed, energy Twitter lit up last month when energy secretary Jennifer Granholm — pressed on the option of switching shipments from the hacked Colonial pipeline to rail cars — conceded “the pipe is the best way to go”.

That misses the point, say activists. If we build pipelines today they will be around for decades, encouraging further fossil fuel production when we need to be weaning ourselves off it.

“Pipelines are another important part of [the climate fight] in large measure because they’re designed to last 40 or 50 years,” Bill McKibben, co-founder of climate pressure group 350.org, told me.

What is the outlook for future projects?

A period of hefty pipeline construction, as developers moved to add new infrastructure to carry hydrocarbons out of areas like the gas-rich Marcellus and Utica shales, is petering out.

“We’re at the end of a pretty significant boom cycle,” Christi Tezak, an analyst at Clearview Energy Partners, told me. “The backlog of projects under review is nowhere near as substantial as it was six years ago.”

After the completion of the Mountain Valley Pipeline in the Virginias — expected next year — there are unlikely to be any other big new interstate projects any time soon.

“What we’re expecting is more focus on incremental capacity expansions, replacements of older pipelines and pipeline projects intended to reduce emissions from associated gas from oil production,” said Tezak.

With or without protests, the era of the big pipeline projects may be drawing to a close.

(Myles McCormick)

Data drill

Savings on electric vehicles go beyond the pump. EVs are also 40 per cent cheaper to maintain compared to their traditional rivals, according to the US Department of Energy. With the Biden administration’s plans to switch 400,000 federally-owned cars to EVs, the government stands to save an estimated $228m each year thanks to lower fuel and maintenance costs.

Bar chart of Maintenance cost per mile in dollars showing Battery-fired cars are cheaper to keep on the road

Power points

  • Coal prices have soared in China, leading to power shortages and fears of inflation.

  • Raising livestock causes major environmental damage. Brazil’s meatpacking industry is now under pressure to prove its sustainability.

  • Glencore bought out its partners in a Colombian coal mine, raising its thermal coal production to 125m tonnes a year.

  • Commodity traders are rushing to invest in clean energy while still holding on to fossil fuels.

  • Lessons from China on expanding the electric car industry.

  • In a poorly regulated, fragmented industry, wind power may help ships decarbonise.

  • Global warming is changing the way Seattleites stay cool.

Energy Source is a twice-weekly energy newsletter from the Financial Times. It is written and edited by Derek BrowerMyles McCormickJustin Jacobs and Emily Goldberg.

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