On the final day of EnerCom’s The Oil & Gas Conference®, a number of energy experts shared their insight into energy market opportunities.
James Constas, EnerCom Managing Director
EnerCom Managing Director James Constas gave a presentation called “Saudi America: the Unexpected Swing Producer.” Constas made the case that three primary factors have determined a cartel’s pricing power: a physical commodity, inelastic demand and both the ability and willingness to control its price. Constas said that when OPEC changed its policy from preserving oil price stability to protecting market share last November, the move implicitly shifted control of supply over to North America’s shale producers—making the shale oil industry the unexpected swing producer.
As Constas put it, “once a cartel loses control of supply, it loses the ability to set price.” He posed that may be one reason OPEC has avoided production cuts up to this point, “What if OPEC cut prices, but the market failed to react?”
Rig laydowns or not, the shale boom isn’t going to quickly stop producing for a number of reasons. “It’ll be drill baby drill until the funds are shut off,” Constas said about those operators relying on debt to outspend cash flow. He said the Saudis and OPEC are counting on nature to slow down the supply coming out of North America, hoping the steep decline curves typical in the most active resource plays, begin to impact production over the next few years, making way for Saudi and OPEC crude.
But OPEC may have underestimated the potential for a free market system to adapt to the new oil price realities. Cost cutting by U.S. producers is going to keep production flowing profitably. Constas cited a 22% decline in Whiting Petroleum’s (ticker: WLL) lease operating expense (LOE) in the second quarter. He said companies are reducing costs both at the field level and they are cutting overhead. Constas cited PDC Energy’s (ticker: PDCE) 16% drop in LOE and a 25%-28% drop in well cost in 2015. We note that many other companies at the EnerCom conference reported significant drops in the cost of operating and production.
“Not only are they cutting operating costs, but the wells are getting bigger,” Constas said, pointing to several large wells announced in 2015 by Whiting, PDC, Range Resources (ticker: RRC) and Cimarex Energy (ticker: XEC) with increased EURs in certain plays in the range of 40%-50%, 30%-35%, and 43%, respectively. In Cimarex’s case, Constas pointed to a 65% increase in 180-day cumulative production for recently drilled wells. Lower costs and more generous recoveries imply that many North American producers with high quality assets are pushing down the marginal cost of supply.
While North American producers have used innovation to quickly adapt their operations to the lower price environment with Herculean cost cutting and efficiency increases, Constas said that OPEC has also learned how to use free market principles against the Western producers. “North America’s oil and gas producers didn’t ask to be the swing producer, but they have learned how to adapt through innovation and cost control.”
Jeb Armstrong, Vice President Energy Research, Marwood Group
“One takeaway I came away with is I think the Saudis are truly in trouble,” Armstrong told the audience.
Armstrong said that the U.S. has largely solved its energy supply problem, citing the statistic that between 2005 and 2015, U.S. petroleum imports fell from 69% to 37% of total petroleum the country uses.
“Clearly the number one issue that the industry is looking at, the number one issue that they’d like to have solved, is the ban on crude oil exports.” Armstrong said the Marwood Group doesn’t believe the ban on U.S. crude exports will be lifted at least until a new president and a new congress are installed. For three reasons. “First a change will require an act of Congress to make it happen. Second, concerns about the effect on U.S. gasoline and diesel prices linger in the minds of many public officials. And third, there appears to be pretty substantial opposition from within the energy industry.”
Armstrong discussed Alaska Senator Lisa Murkowski’s proactive efforts to prepare legislation that would remove the ban. “I think a key component of this is trying to focus in on the national security and foreign policy aspects of it, by focusing on how we can help our allies both in Europe and Asia by providing them important resources and helping them diversify themselves away from the Middle East,” Armstrong said.
Armstrong described the Barton Bill in the House of Representatives as “essentially one line that says: we hereby lift the ban on exports.”
Armstrong reported that there is also talk by certain members of Congress suggesting the possibility of attaching an amendment to the Highway Bill to lift the export ban. “[The highway bill is] a ‘must pass’ piece of legislation,” Armstrong said.