Steady as she goes: US shale sector approaches higher oil prices with caution (Ep. 262)

All right, welcome back to Energy Sense, an S&P global energy podcast covering all topics on the intersection of energy and finance. This is your host, Hylvaden, and I'm here with the other host, Sam Humphries. Sam, how's it going? It was a really terrible time to take a drink. I'm good, thank you, how are you? So we've just spoken about the shale sector with Henry Cookler, who is a returning guest, an S&P expert covering North America, well in gas production, which is being dominated by shale these days, shale production, and he helps to kind of anchor us on kind of how the shale sector is responding or not responding in terms of price signals from Hormuz disruptions and supply, concern throughout inventory, and some other things, can you give people some things to listen to? Absolutely, so the US shale sector has been extremely important, extremely present in over the last 20 years or so. But things are starting to shift in the way the operators are working and how production has been leveraged and utilised, where it's less about producing constantly more and more, and a little bit of a Wall Street drive and that return on investment to shareholders drive. So you're kind of sitting almost outside of the oil price, so we're not seeing those big swings that we used to see 10 years ago or so. And I think he also does a really nice job of summing up what the future looks like in this particular sector, as we talk about stock and inventory and what's next for producers and operators and where they might be looking, but what about you, anything you want to call out? No, you cover it pretty well so we can end up doing it now. All right, Emory, thank you for joining us today to talk about the shale sector and some of the responses to the US shale sector from waning inventory or inventory concerns in terms of wearing room in some of these plays, the response to the straight up or moves concerns around needs for oil production and then on the gas side, some of the data center are increased demand for gas and power generation as LNG export ramp up. So a lot to cover, it's early September, we're most the way through the year, but we've got questions on shale and I think I saw in the paper this morning, oil is at or near $100 today. So plenty to unpack, so Emory, maybe if you could kind of start us off with kind of a status quo, how should we view the shale sector today, what are things to look like in terms of levels of activity and spending? Yeah, well, thanks for having me back here, it's been a while. And it's, I think we called it pretty well at the beginning of the year that the business is very mature in the US, unconventional in particular on the oil side. So the lack of response that we've had makes a lot of sense when you account for some of things you talked about Hill with inventory concerns and price, you know, you can say, hey, oil is 100 bucks, but oil is 100 bucks for a delivery in October, you know, it's hard to turn on a lot of new wells and say we're going to boost production substantially. In anything less than maybe six months a year, even longer than that. And that kind of lends itself to our, what we call the market investment signal, which is what we try to boil down the strip to a single price. And so you kind of take your production curve. You just do a production weighted average per, per barrel price that you receive. And that's been more like $70. So you know, while we've been hitting 80, 90, 100 and above prices, that's not what the operators are realizing if they decide to increase production, because there is that delay. You know, you say, hey, I want to drill a new well. It's going to take a while to get, or drill an incremental well above plan. It's going to take a while to get the rig out there. It's going to take a while to get it completed. By the time you actually add production, you know, you're getting $80 for that first month. And there's still pretty good backwardation on that curve. So a lot of that production is going to end up being around $70. I haven't looked at the strip today, but even just yesterday, our MIS was at $72 when the front month was 93. So when you think of planning price versus what the spot price is, that's a $20 difference. And $70 is a long ways from 90 when you're talking about having room to grow production wise. I think there's also, we did, we broke down and put a little two by two graph of strategy for U.S. operators in our outlook, which is basically you can be aggressive with production or you can be conservative with production. Price can be high or price can end up being low. And there's not a lot of advantage for operators to be aggressive generally, you know, Wall Street really likes these big free cash flows. We thought the number was about a 30% free cash flow, but the past several years operators have been closer to a 45% free cash flow. So that means a lot of that extra, however you want to think about it, extra money is going back to the balance sheet is going back to reducing debt, dividends, share buybacks. And that's what Wall Street wants. And so those are the marching orders. So there's really no upside to increasing production dramatically because you have that preference for a free cash flows, like you mentioned at the outset hill, inventory is an issue as well. You know, if you look at our inventory numbers for the Permian mid to you know, you've got 10 years and then you really have to start thinking about what's next. If you're talking about an eagle ferd or a bockin operator, you know, that number maybe is three or four years and you really have to think about what's next in terms of top tier inventory. Exactly. Yeah. In terms of core inventory. And that's sort of the thing we used to talk a lot about the capital treadmill. If you add more production, well then your base decline goes up and you got to add more production just to keep up with the incremental scale. So all of the sudden that decision to increase production starts to really pull that core exhaustion date in starts to really stress those inventories. So there's a lot of little bits that are adding up to a we're going to keep production pretty flat, maybe grow a couple percent. And that's what we've heard from the operators consistently through the April May calls through the last round, and quarterly updates at the end of the summer, that's a pretty consistent message from the operators. So talking of the operators, I'm sure I read somewhere that in 2024, something like 80% of the transaction deals emerged as an acquisitions in upstream in North America was dominated by upstair, the sales sector companies and operators. So that pool of people who are drilling this well as ramping up that production has shrunk, and like you said, you mentioned some points there that there's messages from Wall Street to keep things, but what has that limiting of the diversity of operators? How has that impacted the sector at the moment, as with moving into the end of 2026, 2027? Has there been like a significant change in the drive in that competition, or is it not so much? Definitely, we did a little look back. If you go back to 2019, there was probably 50 or 60 companies were talking about the drove production, and none of them were particularly dominant, they'd be two, three percent of production per operator. If you take that for this year, it's probably more like 20 operators that really matter. And they're bigger, they kind of have a more conservative profile. We've also lost a lot of the private operators, where you used to have, you know, there was somebody sitting in an office in Tulsa or Dallas or whatever, they could say, we're going to boost production 20 percent next quarter. That's a whole different approach to doing things than sort of pushing everybody into the large independent category. So that's where most of the operators are now. We really have one or two, maybe three significant privates that I can think of the top of my head. companies that have substantial scale. So that's certainly changed the outlook as well that everything's kind of pushing towards more conservative. It's usually sort of a one plus one is equals 1.8 when it comes to merging these companies together. And so that's kind of kind of a good overview of where we are, you know, nine months into this year, right? And so kind of a study she goes down a lot of upside to changing my whole plan to respond to what could be a short term price signal. Do we expect that thought process to continue? I mean, over the next three or four months, these management teams are going to be sitting down and saying, all right, what are we going to do in 2027? Is your expectation that that that kind of a the misaligned incentives or maybe not misaligned incentives, but the expectation that we're going to preserve, we've got fortress ballot sheets right now and we're going to preserve those and, you know, study as she goes. I think that pretty much is the expectation. You know, I'd love to have something very dramatic to say or shake things up, but in this one, it is sort of a very, it's in mature business and very well consolidated, very much focused on the free cash. Well, I think what would change it, especially when you look out at the strip for sentiment about price, that consistently is, hey, this is this is some sort of temporary, you know, is it six months is it a year, whatever, and as Hormuz resolves itself, it's not worth really jumping, jumping on production. If there's something that indicates there's a clear structural shift and price where hey, you know, generally the new price is 80 or 85 or 90 dollars. That might start motivating a bit of production growth because any of those barrels are going to be worth more. You may as well produce them now, but it would need to be something like that. It would need to be something substantial that gives a clear signal, not a 95 dollars today in $70 and a year, but okay, oil is now, you know, rebased at 80 or 85 or 90 dollars, something like that, which definitely isn't our base case, and I don't think it's the highly probable case for most of the commentary out there right now. So you mentioned inventory, and I think that's something I would really like to talk a little bit more about, and you mentioned some quite startling numbers in terms of, you know, what people have on the books. But if we, even if we just take a look at the Permian, maybe just, and the concerns there about that inventory quality, so not only quantity, but the quality of the shell there. Are estimates overblown? Are we exaggerating the potential pitfalls that could, you know, hinder operators in the future? Isn't content in terms of production? Or, you know, is it a very real challenge that people are looking at to try and backfill some of that inventory? It's sort of a little of both. So if you just look at the raw numbers, if things sort of maintain how they are today, it is, you know, eight years, seven years, you're looking at core exhaustion in the Permian. No doubt about that. If you just look at the numbers, that's how it's going to work out. We've heard a lot about lightweight profit, you know, surfactants, different completion approaches. We haven't seen that work out in the data yet. You know, when we look at sort of a per-well, normalized for location quality, normalized for lateral length, all those sorts of things. The best years were around 2017, 2018. So we're even starting to see a little drift lower generally in productivity. And that's control, you know, say to your tier one acre, isn't quite as good as it was five years ago. Your tier two acre isn't quite as good as it was five years ago. The flip side to that, of course, is all it takes is one breakthrough that makes its way through the industry relatively rapidly. So, you know, you hear about EOR. You do hear about these constant sort of trying to figure out completions. You know, it's always sort of the thing and oil gas, you know, it's pretty remarkable that we leave 90% of the oil in the ground as production starts to fall off. It's hard to believe. All this money and all this people and all this AI technology can't find a way to make that 12 or 15 or 18%. We just haven't figured that out yet. Especially, we just opened up our long-term outlook this year to 2060. And so you start thinking about, you know, what's going to happen in the 2050 as well, you know, who's to say the robots won't figure something out, you know, when we're nonsense tied. So give them 20 years to figure it out. Who knows? So I think that's kind of the flip side. If you just look at the numbers, all things equal, yeah, 2032, 2035, that's going to be a clear inflection point. Capital efficiency looks a lot worse. But that's also 10 years of technology to help figure things out. So that's that's the big wild card. I'm tempted to take your bait here and ask you about the 2050 to 2060 expectations with the robots and the flying surfboard. I'm going to resist the urge and ask instead about gas, right? So for, for I'll say years, the shale sector has very much been focused on oil. Very, very much been focused specifically on the Permian basin and as fantastic stories to tell and evidence to show on the operational and the commercial success from that. Shale, of course, got at the start with gas, right? And gas has been one of these, you know, next year's the year story. You know, you've heard that more than once, you know, here every year, but you heard it more than once, right? And that gas demand story is much more in play today than it was called five or six years ago when there was concerns of kind of just how much use will the world have for fossil fuels. How should we think that is are these operators shifting a lot of the attention to gas? She's still got all that associated gas coming out of the Permian with the oil production. How should we think about the role of the gas plays if the inventory on the oil way to place is kind of reaching the end of its life? Yeah, I think certainly that's the bigger story in the US probably now is that, you know, we kind of went through and described how the oil story is pretty well mature or pretty well situated. The gas story, of course, with so much LNG, so many data centers, so much power coming on stream. You know, we go through the forecast, we're trying to find gas. You're right, Hill, the Permian is a big part of that, you know, probably almost a third of gas in the US is coming from the Permian. The GRs keep going up the gas oil ratios. We start seeing more gas per barrel of oil coming from the Permian. I don't we've made a little bit of a jump forward in our data and we're getting a square mile per bench, so Wolf Camp A, Wolf Camp B, G-O-R, type data. And when you look for a gasy region in the Permian, it's really not there. You know, you say, hey, you know, just go up north and go get the gas in the Permian. There's not much there. There's the Alpine High, but that kind of petered out a few years back as relatively small. But, you know, back to your question on the gas plays, the story in Appalachia is always going to be above ground. The pipeline, you know, we're we've floated pretty close to those pipeline limits, whatever it is exactly 38, 40 BC F a day. Wet helps is the local demand. So you're in that PJM area, you know, a lot of potential to not even have to cross the state line and be able to use that gas. So that lets us crank up Appalachia a bit in the long term. We are counting on probably some pipeline expansions, you know, continue to kind of keep plucking away at the EQT, getting on, getting to the southeast kind of further and further with their pipeline, the potential for other projects like Borealis to get on some of these pipelines that aren't entirely filled up. But is it the TGT, Texas gas transmission? Has some rooms, so it's finding a way to get Appalachia gas to that pipeline. So there's some potential to grow there, but we still leave probably 30% of Appalachia in the ground, 40% of Appalachia in the ground by the time you get to 2060 because of the above ground constraints. The Haynesville, that's another one where, you know, in our view, you start looking at core exhaustion, you know, early 2030s again, because that's really the lever we're pulling the hardest to make sense out of this whole supply and demand mix. That's the low-cost gas that can ramp up, that is so close to the LNG. demand and even some of that data center demand and then it's kind of a similar story. Once that starts to Peter out mid-2030s, we do have some secondary resources, we're getting some old familiar names in the mix like the Barnett and the Woodford and Oklahoma and some of those secondary sources but that does mean the Henry Hub probably needs to be in current dollar terms closer to five dollars by the time you get to the mid-2030s to motivate that production to get out of the ground. So there will be a change in the landscape there, it won't be just, there is a resource behind the Haynesville, it just comes at a higher cost so there will be a shift to higher cost gas within the next decade for our source of supply. So I guess if you're looking forward, I'm kind of intrigued as to what you think would make the difference between a successful story for one of these operators and I'm not going to say unsuccessful but not quite as successful. Story, is it then diversifying into other areas, apologies for my ignorance and US operators and are they diversifying to include some, like you just said there, some of that more expensive gas that could potentially bolster their overall portfolio or they focus in a specific base on a play, just trying to understand the landscape and what sort of those operators are doing to future-fuse themselves basically as we kind of go into this sort of decline in that inventory in those resources. Yeah, I think it's still kind of in there, really stages. There are a couple of folks that talked in there, a couple of companies that mentioned in their quarterly calls, you know hey we're in a great place now, we've got to figure out how to start using some of that money to put us in a great place in the next decade or so. There hasn't been a lot of exploration in the US, you see like the Western Haynesville, that was sort of column stocks, thing kind of finding other parts of the Haynesville that worked vertically, you know 20 or so years ago. They're still kind of struggling their way through that, but you know, it's something, it's exploration, it's a new play. We've been talking about really probably the same 10 plays for quite a while now. You know, there's a Permian, there's the Marcellus, there's the Eagle Ferd, there's the Bokin, there's the Utica, and that's been most of the story. So getting anything new has been kind of tough, and you got the Western Haynesville, you've got Scoopstack, never really made it to a huge scale, the Powder River, never made it to a huge scale, you've got, you went to, there's little things, but there's not been a lot of opportunity to diversify. And that kind of takes to the next thing is the International, that's certainly been the news in the past year or so, especially the Middle East, which of course, if you're looking for gray source rock, without a lot of above ground constraints, the Middle East is a pretty logical point, and you've got many of the biggest operators mentioning that, so like a E.O.G., a continental, certainly is one, Oxy Devon, I'm probably leaving somehow going through this quickly, but a number of the operators are going to say, okay, hey, we got to think about what's next, and part of that seems to be leaving the United States, or venturing outside of the United States, not leaving the United States, they'll be plenty of production here for a long time, but that incremental barrel may not be coming from the lower 48, maybe coming from somewhere else, very incremental. So how should we think about that? I mean, you mentioned the source rock and some of the above ground, I suppose, legislative constraints that make the Middle East attractive, the Middle East has a whole bunch of other above ground constraints that make it less attractive right now in terms of finding market for anything that needs to get out of there. Argentina is, of course, of interest, and we've talked, you know, the start of this podcast on some of the recovery potential, and the DOE is making money available to try to improve recovery rates in, you know, U.S. sale. If you're an executive right now, and you're seeing this kind of inventory concern around 2030, are you, you know, boxing up maps and saying, all right, you know, this has been fun, but on, you know, January 3rd of 2032, we need to look for other things to do, or are you saying, I'm going to place my bet in an international sale. I'm going to place my bet in technology U.S. Am I going to look north to Canada? You know, if you were one of these executives, and these are your options, which are bet technology outside of the U.S., outside of the U.S., Canada, outside of the U.S., you know, another country entirely? Yeah, I think I'm going to take the opportunity to weasel out of your question a little bit when you're boxing up your maps, right? While I'm boxing up my maps, I'm opening up the maps across the Middle East. I'm also, you know, talking to my friends in Austin or Silicon Valley about, hey, how do we crack some of these codes and pull EOR over and make it work? I mean, you're sort of at the, the angel investor stage, so to speak. Like you said, he deals. Sure, the Middle East probably has some good source rock, but you face all kinds of challenges about marketing and getting modernized contracts and, hey, what about security out there and all those kind of things? Technology is always going to be a crapshoot, you know, hey, maybe things could go really well and you get twice as much oil as you thought you would get out of the Permian, but that, of course, is still not something you can quite bank on yet. So I think this is the phase where it's kind of get your, get your money in a couple of different pots, you know, play the slides and play craps and maybe you'll do pretty well. That's the way to do it. Okay. So that's like long distance future thinking. You're always like to sort of round up these conversations with a bit of a closer looking to that crystal ball. So one thing, I mean, the year has been exciting to say the least already, but if there is something that you want to point out that it's going for people to pay attention to in the next six to 12 months, it could be a project or deal anything really within U.S. trail. Go ahead. That was your time. Yeah, I think the message will probably be pretty dull, but if you're looking for, you know, looking for the price, looking for those first hints on the conference calls that, hey, we're willing to break a little more production loose. You know, you do, you're from Diamondback and maybe a few other operators said, hey, you know, we're going to go ahead and take advantage. We're going to pull barrels forward. So there has been a touch of that sentiment, probably not quite broad-based yet. The other thing might be even the service sector. Are you saying that they want to invest in incremental capacity? They have not very much. They have sort of the same free cash flow demands. They haven't wanted to risk capital in new ventures. So, you know, you started to see that maybe a little bit. Liberty had some announcements about, you know, sort of going into integrated projects and trying to diversify a little bit there. In terms of generation, you know, merging upstream capacity with their service sector capacity with their ability to perhaps put together some generation power, whether it's on and greater off-grid, it's going to be kind of incremental. I don't know that you're going to see big surprises in USA. Which is probably a good thing, you know, for so many years it was sort of the black sheep burning a lot of money. But eventually, on the other side of it was some assets that made the US the leading producer in the world. But with that, you know, you're middle-aged, you're slowing down. So, that's kind of where the business is. Congratulations for pouring into the street. Which, in a way, that's a sign of success, right? That's kind of where you want to be. That's the goal, when the go-go days start up, the goal is, hey, this will be a big, important business that won't be as interesting or dynamic at some point. All right. Well, this has been a helpful landscape discussion on what to expect from the shale sector, given all the movements around it. Perhaps, you know, right now we talk about the shale sector and don't really feel the need to say US shale sector, but it sounds like between what's happening in Argentina, maybe the Middle East, maybe Australia, some of these other kinds of plays that are moving around that we start have to defining which shale sector we're talking about by the middle of the end of 2030, or 2030 time period. So, all right, Emory, it's always a pleasure. We'll let you go. All right. Thank you. Thank you.