22 Jan 2021 – Prices Are Up, Will Activity Follow
Any forecasts about what is coming in the next weeks and months for the energy markets has to begin with the disclaimer that things remain fluid. With significant unknowns surrounding the incoming US presidential administration policies, the vaccination pace in Western countries, and OPEC+ moves, yesterday’s gains could easily be tomorrow’s losses in the energy commodity markets.
That being said, the past 10 weeks have seen a rise in the WTI price from the mid-thirties ($36.81/bbl on November 2, 2020) to the low-fifties ($52.84/bbl on January 18, 2021). While I’m always hesitant to put too much stock in the forward strip, the Wall Street Journal reports crude oil futures holding in the low $50.00s through May.
A number of factors are behind this ~70% price increase in just a short few months. For one, despite the likely political/regulatory headwinds for US onshore that will come with the incoming Biden administration, the markets still prefer line of sight/predictability. While the Biden plan is not known, we’ve removed the major unknown of who the next president will be.
Second, despite present tactical challenges to deploying Covid vaccines, implementation is on-going with large-scale inoculation widely predicted by mid-year. As populations experience increased resistivity to the virus from herd-immunity and vaccination, an end to lockdowns and large-scale increase in economic activity is forecast.
Finally, the markets were extremely receptive to the recent Saudi ‘gift’ to producers in the form of a unilateral 1MM/bbl/day production cut through April.
So prices are up, will activity follow?
In sum, activity is predicted to increase, though production growth (and thus activity) is likely to be fairly modest barring additional economic tailwinds. The general consensus – from Rystad to IEA to various private consultancies – appears to be that 2021 will be a recovery year, with global demand returning to pre-pandemic levels in late 2021 or early 2022. This also corresponds to several recent Wall Street Journal forecasts regarding business travel – a key indicator of overall transportation and therefore energy consumption – positing a return to pre-pandemic levels in 2022.
So if prices are up ~70%, why are we not anticipating a dramatic increase in activity? For one, the industry is still working through the surplus supply generated in 2020. According to the IEA, despite the general global demand recovery in H2 2020, US stockpiles remain 12% higher on a year-over-year basis. This, coupled with an anticipated demand recovery in late 2021 means a US stockpile glut lasting through the end of the year. Not exactly conducive to a hockey-stick recovery in activity levels.
Second, investor sentiment and a demand for returns over production base growth have imposed severe capital constraints for the growth-inclined operator. Throughout Q4 2019 and all of 2020, the public markets were quick to punish to those who signaled production growth over returning cash to investors.
Pioneer Natural Resources CEO Scott Sheffield made this case most dramatically in a recent Goldman Sachs investor webcast, where he stated, “I never anticipate growing above 5% under any conditions….” including a $100/bbl environment. While I’m skeptical of these claims, his anti-growth, or perhaps more accurately pro-financial discipline, posture matches similar public statements made by the CEOs of Devon Energy, Inc. and Ovintiv, Inc., two other major Permian and US onshore producers.
Finally, slowing growth rates are natural outcome of the recent wave of consolidation. Simply put, larger consolidated companies will develop assets at a slower rate than they would have as separate companies. Rystad illustrates this point through the most recent Diamondback acquisition of QEP and Guidon. According to Rystad’s analysis, the merged company (or more accurately Diamondback inclusive of its new assets formerly constituting QEP and Guidon) is anticipated to grow slower as a single entity than the three entities would have separately. According to Rystad, as consolidation continues, this will increase the shift towards a more conservative reinvestment environment, resulting in overall slower production growth as less wells come on line.
The more general prevailing outlook appears to be that 2021 will remain a maintenance mode year for most on-shore US exploration companies with slow activity growth and modest gains in overall production. The end of production curtailments and an industry-wide ‘frac-holiday’ are already being felt, as Rystad Energy anticipates production levels to recover from 10.9MM bbl/day in Q4 2020 to an approximate 11.5MM in April 2021. These numbers are expected to further increase to 11.8MM bbl/day in 2020.
However, most recent data points to an overall increase in activity levels, even if slight. Baker Hughes rig data this week points to an overall increase in drilling rigs for every US onshore basin outside of the Bakken and DJ, and perhaps these could be partially explained by season.
If Growth is Flattish, Who Is Actually Growing?
No surprise that the Permian Basin remains the odds-on favorite to be the outlier, experiencing the highest growth rates as we (hopefully) begin to look past the severe impacts of the Covid pandemic. In fact, Rystad predicts the Permian to return to pre-Covid record production levels as early as H2 2022.
Beyond the Permian, increases in price beyond the present low-$50s is anticipated to have the highest proportionate impact on activity in the Bakken. However, Biden policies regarding midstream will have a disproportionate impact on the Bakken’s take-away constraints.
So, to answer the original question – will an increase in price result in an increase in activity? Not proportionally, as in we’re not going to see a 70% increase in activity to correspond to the increase in price, but yes the increase in price has moved activity levels. Time will tell whether the fairly uniform capital discipline message of the major US onshore operators is to be believed. Old habits die hard, and I’ve heard this same story at least two times in the past 15 years.