- Slower production growth in the oil and gas sector raises concerns about meeting EIA forecasts.
- Increasing drilling costs present challenges for small firms and create acquisition opportunities for larger companies.
- Expensive drilling and cash constraints discourage firms from increasing production, despite the potential for higher oil prices.
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The Dallas Federal Reserve released its second quarter survey of oil and gas firms located in Texas, southern New Mexico, and northern Louisiana. 152 exploration and production and oilfield services firms responded to the survey. These include both small E&P companies (production below 10,000 bpd) and large E&P companies (production at 10,000 bpd or higher).
The important takeaways for traders are as follows:
1. Slower Production Growth Raises Concerns About Meeting EIA Forecasts
Oil and gas production increased in the second quarter but at a slower rate than in the first quarter, while activity remained unchanged.
This means that we can expect even less production growth in the third quarter. If activity is stagnant and the rate of production growth is slowing in the most productive region in the United States, can the U.S. hit the production rate forecasted by the EIA for 2023?
The EIA’s most recent Short Term Energy Outlook forecasts that U.S. production will average 12.61 million bpd in 2023. This actually reflects an increase from its January Short Term Energy Outlook, where production was forecast to hit 12.4 million bpd.
Production growth could increase in the 3rd and 4th quarters of this year with little activity growth if E&P firms have drilled but uncompleted wells (DUCs) that they can access. However, it is also possible that the Permian region will not see further growth this year, as firms report that costs are still rising. In this case, the U.S. could likely fall short of EIA production growth forecasts.
2. Increasing Drilling Costs Pose Challenges for Small Firms, Create Acquisition Opportunities for Larger Companies
Most small firms expect drilling and completion costs per well to be higher at the end of 2023 than they were in 2022, whereas large firms expect these costs to decline.
This means that it is getting even harder for small firms to increase production. Without the ability to grow, the ability to sustain their business is in doubt. They may be able to sustain production on wells that are already in use, but the longevity of fracked wells in the Permian is significantly less than conventionally drilled wells.
If small firms possess desirable acreage, then they can expect to be acquired by larger firms, especially while oil prices remain under $80 per barrel. If larger firms have the cash to buy smaller companies with leases in desirable producing regions, this would be the time to do so.
Look for larger firms to acquire smaller firms facing higher drilling costs that are constraining their ability to increase production. Larger firms may choose not to drill in these areas or to drill but not complete wells in these areas until oil prices rise.
3. Firms Aren’t Drilling More Because It Is Too Expensive
This was a common theme across the comments offered by E&P firms. Many firms expressed that they could easily increase production either from higher oil prices or from investment if they had more cash or if it was less expensive.
Although drilling costs aren’t rising at nearly as high a rate as they were last year, costs are still rising. Meanwhile, prices have declined, and investment remains hard to come by.
This means that if costs came down or oil prices rose so firms had more cash, they would increase production. The issue isn’t a lack of quality acreage or a desire to return value to shareholders rather than produce more oil. Higher production is possible, but costs are prohibitive for many companies.
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Disclosure: The author does not own any of the instruments mentioned in this report.