The biggest North American oil and gas story of the new year is the story of oil and gas itself. Commodity prices, of course, always dictate industry actions, but the latter half of 2018 and the first weeks of 2019 has been a particularly volatile time.
West Texas Intermediate crude hit an 18-month low on Christmas Eve, then rallied 24 percent, to $52.59 a barrel on the New York Mercantile Exchange. It was the strongest bull run for crude since 2010.
The agreement among Russia and key OPEC members such as Saudi Arabia to curtail production helped to reverse the year-end declines for WTI. But there’s no mistaking that the North American energy markets have changed fundamentally. Thanks to hydraulic fracturing, vast new reserves are being unlocked in the shale formations of the Permian Basin in West Texas, making it the second-most prolific basin in the world behind Saudi Arabia’s Ghawar Field. During the past two years, Permian production has jumped to more than 3.6 million barrels a day from 2 million, and forecasters predict the growth — 63,000 barrels a day in December — will continue apace.
The Permian now accounts for almost half of all U.S. shale production and is the key driver behind the country’s return to prominence as a major oil producer. In fact, the U.S. now has so much influence in the global market that OPEC is considering lobbying U.S. lawmakers for the first time in the cartel’s history. Meanwhile, other U.S. shale basins such as the Eagle Ford and the Anadarko are showing signs of resurgence as well. The Anadarko is on track to become the second-most prolific basin behind the Permian.
Growth from the Permian will likely continue to keep global crude prices in check. The drilling frenzy in the region has created a glut in production because of a lack of pipeline capacity. Drilled but uncompleted wells (DUCs) surged to 1,300 in the first nine months of 2018. Oil at the wellhead was selling $18 a barrel less than crude selling on the Gulf Coast.
For natural gas, the prospects were even worse. U.S. benchmark gas for February delivery was selling for $3.16 per British thermal unit in early January, but at the end of 2018, West Texas gas was essentially worthless. Prices hovered near zero and some trades fell to negative 25 cents.
New pipelines are being built, including a Kinder Morgan project to transport natural gas to plants in Corpus Christi, Texas. By the end of 2020, analysts expect as much as 3 million barrels of additional transport capacity to be added in the region.
Ironically, the stranded gas in West Texas comes as demand for the fuel for heating increases in other parts of the country as well as for liquefied natural gas exports, primarily to Asia. That growing demand is revitalising another basin, the Haynesville Shale in eastern Texas and north-western Louisiana, where more than 50 rigs are now active.
The biggest U.S. exporter of LNG, Cheniere Energy, recently began shipments from its new facility in Corpus Christi in addition to its Sabine Pass plant on the Texas-Louisiana border. Several more export terminals, including one in Freeport, Texas, and Cameron, Louisiana, are schedule to begin exporting gas later this year.
Rigs drilling for natural gas in other basins, such as the Marcellus Shale in Pennsylvania and New York inched up in early January. Even so, any resurgence in the Marcellus hasn’t been enough to help EQT, the biggest U.S. gas producer. EQT bought Rice Energy for $6.7 billion in late 2017, giving it more gas reserves than Exxon Mobil, but the company’s shares have fallen 42 percent since then as promised cost-savings have failed to materialise. Now, the brothers who ran Rice have launched an effort to take over the combined company and oust EQT’s management.
Analysts have waited for more than a year for consolidation among shale drillers, but so far, even big 2018 deals like Concho Resources’ $9.5 billion purchase of RSP Permian or Diamondback Energy’s acquisitions of Ajax Resources and Energen for a combined $10.4 billion have fallen short of the reward for which shareholders hoped.
As we head into 2019, analysts will again be waiting for signs of the long-awaited consolidation wave. But the lesson of 2018 is that bigger isn’t always better when it comes to shale production. Typically, innovation in onshore production starts with the wildcatters, the small independents who are willing to take more risk. Then, the larger companies move in to capitalise on the trend.
While companies such as Exxon Mobil and BP have invested billions in shale production during the past year, the Permian remains a hotbed of smaller producers, many of whom are reluctant to sell despite the urging from private equity firms and activist investors. That kept the stocks of many shale producers lagging commodity prices for much of last year. Some smaller company CEOs clearly believed they could sell for more later, and as long as interest rates remained low, they could continue to raise the capital they needed.
However, with interest rates rising and the dollar strengthening, which makes commodities more expensive in the global market, companies may finally begin to feel the pinch of shale drilling’s ugly truth: While improving technology has lowered break-even prices, enabling many producers to report earnings even at lower prices, the industry still spends more on production than it makes. In October, the Institute for Energy Economics and Financial Analysis published a study with the Sightline Institute that examined the finances of 33 companies at the centre of the fracking boom. They found that for the first six months of last year, the companies spent almost $4 billion more on drilling programs than they earned on production.
Investors have grown increasingly frustrated with this process. If the stock market volatility of the past few months continues into 2019, they may view oil and gas as speculative investments to be avoided. Fracking has upended the global oil markets and petropolitics. The challenge for the North American oil and gas industry in 2019 is proving to investors that the incredible growth and energy abundance it has unleashed is sustainable.
By Loren Steffy
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