From The Wall Street Journal

Smaller, nimbler companies pioneered the U.S. shale boom. But as American production scales up, those frackers are losing ground to Big Oil.

Giant companies such as Chevron Corp. CVX 1.00% and Exxon Mobil Corp. XOM -0.08% are increasing shale production faster and with fewer complications than their smaller rivals. Their superior size and deeper pockets give them an edge in planning large drilling projects and locking in the pipeline and labor deals needed to ensure profitability.

Exxon doubled its shale rigs across the U.S. from the end of last year through September and became the most active driller in the country, according to industry tracker RigData. Chevron’s output in the Permian Basin of Texas and New Mexico rose 80% for the year ended in September, eclipsing some of the small producers that spent years building up their fracking positions.

“You need scale once you’re in development mode to be able to succeed at the margins that you have,” said Jeff Shellebarger, Chevron’s president of North America exploration and production.

Size also helps larger companies weather volatility in the oil markets, where U.S. crude prices have plunged more than 20% in the past month to about $56 a barrel. The bigger companies kept spending in check as oil rallied earlier in the year, making them less vulnerable to the recent selloff. As a result, Exxon shares have fallen only 4% in the past 30 days, compared with the 17% decline in the index of smaller producers, according to FactSet.

Smaller exploration and production companies recently reported their best third-quarter performance in five years, thanks to higher oil prices earlier in the year. Of 27 independent producers, 23 were profitable, including EOG Resources Inc. and Continental Resources Inc.The companies’ collective net income totaled about $6 billion, compared with $2 billion in losses a year ago.

Bigger producers also reported strong quarters. Global oil companies including Exxon, Chevron,BP PLC, Royal Dutch Shell PLC, Occidental Petroleum Corp. and ConocoPhillips made almost $5 billion in the quarter from their North American drilling units, up from a $373 million loss. While those results include areas such as the Gulf of Mexico, most companies said shale production was a significant factor.

The bigger companies have benefited in shale drilling from being able to ramp up production with fewer obstacles from Texas to North Dakota. Smaller operators, meanwhile, faced challenges such as pipeline bottlenecks that forced some to scale back drilling plans or move rigs away from areas where the constraints were most severe.

“Scale is so important in shale,” said Uday Turaga, chief executive of ADI Analytics, an energy consulting firm. “You can drive down costs from suppliers, secure pipeline access more quickly and get better contracts.”

Independent exploration and production companies also hedged much of their oil production to protect themselves from the downside risk of falling oil prices. That was crucial protection for many smaller, less well-financed shale companies, but it prevented them from fully capitalizing on the upswing in oil prices.

About three-fourths of the smaller companies have spent more cash than they have generated from drilling so far in 2018, a metric many investors track to monitor the financial sustainability of the industry. Collectively, they have outspent their cash intake by about $5 billion, according to FactSet data.

While many big oil companies were slow to fracking, bigger companies have tended to benefit as technology matures and drillers shift from exploration to large-scale production.

That trend is most apparent in the Permian Basin. Large companies including Exxon, Chevron, BP, Shell and Occidental this year are set to produce an average of about 600,000 barrels a day of crude in the region, up 54% from last year. By 2021, their output there will exceed 1.1 million barrels a day, or about 20% of the area’s total shale-related output, according to consulting firm Rystad Energy.

Chevron’s Permian Basin production soared to more than 330,000 barrels of oil and gas a day during the third quarter, an 80% increase from a year earlier. By comparison, it took Parsley Energy Inc., a smaller operator, four years to boost its production to 100,000 barrels from 10,000 barrels.

Larger, integrated companies have managed to avoid many challenges that have plagued independent producers, whose U.S. production increased by an average of 17% in the past year, according to a review of company disclosures.

Hedging is projected to cost top drillers more than $5 billion this year, according to a Wood Mackenzie analysis of the larger companies that hedge their oil and gas production.

The recent drop in oil prices is likely to mitigate hedging losses. However, on average, the companies’ hedging programs don’t begin to generate gains unless crude prices fall below $56 a barrel, Wood Mackenzie analyst Andrew McConn said.

Oil giants generally avoid those kinds of futures contracts. Because their market size dwarfs small drillers, they face limited pressure from lenders to hedge, and their hedging losses have been muted.

Pipeline access is another area where bigger companies fared better. As U.S. oil production soared above 11 million barrels a day, growth exceeded existing pipelines, forcing smaller companies to sell their oil at a discount. Crude sold in the Permian Basin was discounted by an average of $14 a barrel during the third quarter, according to S&P Global Platts. That differential has since contracted to about $5.

Larger oil companies have historically secured enough pipeline capacity from any oil field in which they are boosting production to avoid having to sell crude at such discounts. Many own or build pipelines outright.

That helped Occidental, one of the largest Permian Basin producers, realize nearly $800 million in profit from its pipeline and trading business during the third quarter, more than three times the income from its U.S. drilling business. Vicki Hollub, the company’s chief executive, said the company’s integrated business model proved advantageous.


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