Deflation Is Coming to America’s Shale Oil Fields
The drop in production costs is forecast to accelerate in coming months, providing welcome relief to US energy companies grappling with lower crude prices.
By Kevin Crowley July 5, 2023 bloomberg.com
While inflation is persisting across the US — albeit at a slower pace — the country’s oil fields are a rare corner of the economy where prices are actually dropping.
Drill pipe prices have halved this year, daily rig rates are down by more than 10% and the costs of steel and diesel are also trending lower. The number of active oil rigs has dropped 13% from this year’s peak, indicating there’s a surplus of equipment in the market. The only major holdout is labor, with hourly wages still on the rise.
Overall, US oil production costs declined by 1% in the second quarter, marking the first drop in three years, according to Goldman Sachs Group Inc.
The pullback may seem modest — especially compared with a 50% increase in Permian Basin well costs from 2021 to 2023 — but it’s poised to gain momentum in the coming months, analysts say. All told, costs will be about 10% lower next year than this year, according to Citigroup Inc.
For US oil companies, it’s welcome relief.
Production cuts from Saudi Arabia and Russia have done little to support oil prices that are down about 12% this year. After record profits and index-leading performance in 2022, US energy stocks have underperformed the S&P 500 by more than 20 percentage points in 2023.
Like several banks and hedge funds, many oil executives were expecting crude to run up to $100 in the second half due to a Chinese economic resurgence that has yet to materialize.
In the field, companies likely will use the lower costs not as an opportunity to drill more but rather to reduce their budgets, according to analysts at JPMorgan Chase & Co. Most publicly traded companies will try to keep output flat or growing modestly while reducing their capital spending by 5% to 10% next year, they said.
Financially, lower outlays should help producers cushion — rather than reverse — the drop in free cash flow this year. Many are likely to reduce share buybacks and variable dividends when they announce second-quarter earnings next month, and they’ll need to focus on cost reductions to spin a positive story to investors.
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