The Fracking Boom’s Midlife Crisis
Crude prices bouncing around $50 to $60 a barrel have kept U.S. shale producers stuck on the edge of profitability. That hasn’t been enough to shut down the oil boom in places such as North Dakota, Texas, and New Mexico—at least not yet. Drillers are heading into 2018 on the defensive as they face skepticism from shareholders who want to see less investment and more profit. They may also be finding that much of the easy oil has already been pumped.
“There’s a complacency that shale is going to continue to produce at the kind of volumes that we had in the past,” says Jim Brilliant, a portfolio manager for Century Management Investment Advisors in Austin, whose investments include shares in energy-related companies. Output has recently failed to meet expectations. As of June, the U.S. Energy Information Administration expected an average of about 9.3 million barrels a day, more than 220,000 barrels a day higher than companies reported.
Investors are demanding that companies sell off weaker holdings, pare spending, and pay down their debt, wrote Paul Sankey, a Wolfe Research LLC analyst, in a Sept. 5 note. Shale producers traditionally market themselves as growth companies. With few exceptions, they eschew paying dividends and buying back shares, and instead plow their money into more drilling. Many are still outspending their cash flow. But their shares haven’t cooperated with this strategy: While the stock market has reached record highs this year, an S&P index of oil and gas explorers and producers has plunged about 17 percent. “I think people are disappointed for all the right reasons,” says Tom Driscoll, a Barclays Plc energy analyst.
Executive pay incentives for exploration and production companies are under scrutiny from investors, too. “The compensation plans laid out by E&P corporate boards encourage these companies to grow production at almost any cost,” says Kevin Holt, chief investment officer for value equities at Invesco Ltd. For example, pay may be tied to sales volumes or additions to reserves, rather than measures of cash flow. The strategy “builds the personal net worth of the CEOs but does nothing for the shareholders for whom they are legally fiduciaries,” says Holt.
Drillers also face technical questions about the shale boom’s sustainability. Pioneer Natural Resources Co. and Parsley Energy Inc. reported higher-than-expected natural gas output from their wells in August. That sent shares tumbling, because traders took it as a sign that oil flows, which are more lucrative, might peak more quickly than the industry expected. (As wells age, they tend to produce more gas and less oil.) The companies said their oil production hadn’t diminished, while analysts dismissed the worries as overblown.
Still, the market’s anxiety attack came amid other warning signs. In July, London-based investment manager Horseman Capital Management Ltd. noted government data that showed U.S. shale wells were petering out at a quickening rate and questioned whether it was the result of increasingly intense drilling. Later, industry consultant Wood Mackenzie Ltd. warned breakneck development could be “testing the geologic limits” of U.S. shale’s crown jewel, the prolific Permian Basin, which straddles the border of Texas and New Mexico. “If you look at what the industry is set up to do in the next three years in the Permian, they are going to push on the rock harder than we’ve ever pushed on a shale play before,” says Robert Clarke, a research director at Wood Mackenzie. A shortfall there could ultimately affect world oil prices.
For some producers, that will be good news—if they can keep their own wells pumping as overall output growth slows, letting prices rise. “U.S. production is not nearly the Big Bad Wolf that everybody thinks,” Mark Papa, chief executive officer of Centennial Resource Development Inc., said at an investor conference in New York in September. But oil consumers could be in for a shock. “If the world keeps believing we’ve got surplus oil as far as the eye can see—which I don’t believe—then the reality is going to smack everybody in the face,” Century Management’s Brilliant says. “And it will be hard to catch up.”