It is now common knowledge that shale revolutionized the U.S. oil industry, as the boom led the U.S. to move from a net oil importer to a net exporter -- which has and will have severe implications for U.S. foreign policy, but that is a debate for another day. U.S. Shale production went from 5.8 million barrels in 2017 to 9 million barrels in 2020, an estimated 55% growth. In 2018 and 2019, the year-over-year annual growth was around 1.5 mln and 1.2 mln barrels, respectively.
Most sell side and academics have now become so used to rampant U.S. shale growth that they are modelling the same linear projections for not only this year but for years to come -- modelling is an art not a science. In 2020, most academic and multilateral, institutions like EIA, IEA, OPEC or whatever government body looks at the past rather than what can happen in the future, are predicting U.S. shale to grow by a similar amount -- around 1 mln bpd. They are unable to look at indicators in real time and gauge what will be the impact until after it happens. And therein lies the beauty.
According to a recent HFI Research note, using an estimate of 11,728 wells to be completed this year, they estimate U.S. Shale growing around 424,000 bpd. That is quite a stark difference from the figure suggested by the above bodies. That is the difference of all the cuts OPEC and their friends are suggesting. The Baker Hughes Rig Count has been declining for quite some time and it is no surprise that U.S. oil production has been resilient despite this, due to more efficient drilling and optimizing on older wells drilled but not completed.
Also, over the past few years, these companies raised a lot of cash, with capital markets open to them and greedy investors being lured by their growth rates. They over-spent and over-produced and ran their cash into the ground as oil prices just kept going lower, killing the rest of the competition. But times have changed and so has investors' patience. Over the past quarter, these same shale companies are now making pledges to their investors that this time it's different -- but do they believe it? Investors are now in show-me-the-money mode. Companies have cried wolf too many times, so their disbelief can be forgiven. But this time when no one is listening, the companies are doing the right things.
Yesterday, three of the main U.S. Shale companies reported earnings -- Concho Resources $ (CXO) , Diamondback Energy $ (FANG) and Pioneer Natural Resources $ (PXD) -- and beat their Q4 2019 estimates by 28%, 6%, and 12%, respectively. That is outstanding, given it is the energy sector, which has been a dog in general compared to the S&P 500 and technology, in particular. What stood out was that all three yesterday hiked their dividends, finally adhering to their capital discipline pledges. Pioneer raised its quarterly dividend by 25%, Diamondback doubled its dividend, and Concho raised it by 60%, and all announced subdued capex spending for 2020.
So where is all the U.S. shale growth coming from? With declining well productivity in Bakken, Eagle Ford, Niobara, this being the first year-over-year decline since 2016, it seems the Permian is the only basin that will see any growth this year, with production growing about 525,000 bpd according to HFI Research. It is essentially holding down the fort -- but for how long?
The thing about shale is that as the wells mature, companies need to spend more and more to keep pace with the natural decline rates. Hence, the new production growth rate is seen to also be falling off of a cliff here after 2020. At a time when OPEC+ has already taken about 1.7 mln bpd of oil out of the market and is talking about cutting another 500,000 bpd, this can severely tighten the market towards the end of this year, especially as the effects of the Coronavirus demand slowdown wear off.
U.S. shale has been OPEC's nemesis for some time, but the tide could turn, helping them gain some market share as these guys slow down after years of overproduction. Regardless, the oil price sub $55/bbl Brent is not sustainable for long, given most projects and countries need higher breakevens to be sustainable and as China moves past the peak of oil demand destruction, as factories and businesses return to operation.
With China lowering its overnight loan prime rate further by 5-10 bps on Thursday morning, along with other measures to stimulate the economy, the oil price and the sector is a buy here. But be selective and be in names that are growing even in a flat price environment, returning cash back to shareholders, like the Permian players above.
