Posted on October 19, 2017
The Secretary General of OPEC, Mohammed Barkindo, has a message for shale drillers. Speaking at an energy forum in India, he said, “We urge our friends in the shale basins of North America to take this shared responsibility with all the seriousness it deserves, as one of the key lessons learned from the current, unique supply-driven cycle.” In other words, start sharing some of the responsibility to help keep excess supply off the market.
His plea comes as U.S. output has staged a remarkable comeback this year and is on pace to break the 1970 record of 9.6 million barrels per day by next year. However, the message will probably fall on deaf ears, since shale drillers aren’t beholden to OPEC but shareholders. So the only way for OPEC to get its message across would be to take away the one thing shale drillers need to keep drilling, which is a stable oil price — that is, unless shareholders persuade them to use their money for something other than drilling more wells.
How we got here
The oil market is still trying to get back on its feet after a blistering downturn caused by a gusher of new supplies, primarily from U.S. shale drillers, that flooded the market in recent years. OPEC initially responded by unleashing its own torrent of oil, which it hoped would drown out weaker shale drillers. However, instead of killing that emerging industry, it has only made shale stronger, because good old American ingenuity drove out costs through efficiency gains and innovation. Consequently, many shale drillers are now thriving at $50 crude.
That’s a problem for OPEC, because it’s trying to rebalance the oil market by coordinating a production cut to drain excess inventory. While those oil stockpiles have fallen this year, they haven’t come down as quickly as hoped, because shale drillers promptly ramped back up.
The only message that will get through
While the OPEC Secretary General had a pointed message for shale drillers, he also offered the industry an olive branch. He reminded them that “we all, at the end of the day, when all is said and done, belong to the same industry and operate in the same markets.” He therefore said that countries participating in the current Declaration of Cooperation could consider “some extraordinary measures” to ensure a sustained rebalancing in the industry over the long term. In a sense, he was suggesting that if shale played ball by holding back, OPEC would do what it takes to stabilize the market, so that prices are more appealing to all producers.
But the only thing that seems to cause shale drillers to reduce spending — and therefore production — is lower oil prices, since the cash flow from crude is their lifeblood. That’s clear by taking a look at what happened when oil slipped into the $40s earlier this year. In response to that decline, Whiting Petroleum (NYSE: WLL)
was among the shale drillers that slashed spending
, cutting $150 million from its 2017 budget in late July to better match capex with cash flow. Whiting had to drop two drilling rigs from its plan as a result of the spending cut, and now production is on pace to rise 14% by the fourth quarter, down from its initial estimate for a 23% increase by year’s end.
Likewise, Pioneer Natural Resources (NYSE: PXD) cut $100 million out of its budget after choosing to defer the completion of 30 wells until next year. While a drilling delay helped drive the decision to slow down, Pioneer said it could have reaccelerated but decided against doing so “in light of the current commodity price environment.” As a result, Pioneer expects output to come in at the low end of its guidance range.
Shareholders to the rescue?
Given that most shale drillers will only cut back when crude falls, OPEC’s only option to get its message across might be to let the current output reduction agreement expire next March. Doing so could put enough pressure on oil prices to prevent a repeat of this year when several shale drillers ramped up spending, with Whiting, for example, doubling its budget.
Still, if OPEC sees that shale drillers are starting to take their responsibility more seriously, it increases the likelihood that it will extend that agreement, which could keep prices stable. We’d see evidence of that option if more drillers follow Anadarko Petroleum (NYSE: APC)
and use their financial resources to ramp up cash returns to investors instead of spending it to expand production further. It’s a move that has already paid off for Anadarko’s investors, given that the stock rallied sharply
after it announced a $2.5 billion repurchase program. One of the drivers of that rebound is that Anadarko could retire as much as 10% of its outstanding shares, which would push its per-share output up by a similar rate. If shareholders start demanding that more drillers use their cash to grow returns instead of production, it could be just the thing the industry needs to prevent drilling itself into another hole by causing OPEC to fight back again.
Waiting for the right messenger to speak up
OPEC wants shale drillers to help it stabilize the oil market. However, words alone aren’t likely to get them to change gears, because they answer to shareholders. Therefore, other than a drop in oil prices, the only way they’ll cut back is if shareholders demand that they do by turning up the heat on capital returns. If drillers are smart, they’ll see the way investors responded to Anadarko’s buyback and begin making plans to boost shareholder returns instead of just production.