Inflation drives up drillers’ costs in US shale oil patch

Inflation drives up drillers’ costs in US shale oil patch

Inflation drives up drillers’ costs in US shale oil patch

The supply bottlenecks and labour shortages felt across the US economy are driving up the cost of shale oil production, a trend that is helping to underpin the price of crude.

Expenses including steel, wages and contracts to hire drilling rigs are on the increase. Cost inflation in the oil patch is likely to run at 10 to 15 per cent next year, much faster than the broader US price indices, forecasts Artem Abramov, head of shale research at Rystad Energy.

This could have consequences for global oil markets. Moody’s, the debt rating agency, recently raised its expected oil price range for the next two years by $5 a barrel, to $50 to $70 a barrel, noting that “production costs started to rise in step with oil demand and a broader economic recovery”.

Oilfield service companies, which carry out tasks such as drilling wells and disposing waste, have warned for months that they will shift the rising cost burden of supplies and wages on to producers.

Jeff Miller, chief executive of Halliburton, the third-largest oilfield service company by revenue, said in July that there had been “inflation in many parts of our business,” adding, “but we’ve been able to pass that along”.

Oil has been trading at seven-year highs, with West Texas Intermediate crude above $80 a barrel, as petroleum markets spring back from the lockdowns at the onset of the coronavirus pandemic in early 2020.

The oil price is enough to make most new wells profitable to drill even with rising costs, Abramov said. Forecasters expect that American oil production will grow by about 800,000 barrels a day over the course of 2022, a sharp increase from this year.

The number of rigs drilling for new oil and gas wells, a key indicator of industry health, has grown steadily to 533, nearly double what it was this time last year, according to oilfield services company Baker Hughes.

But as the industry has tried to expand again it is running into the kinds of supply chain and labour problems bedevilling consumer brands such as McDonald’s, Ford and Walmart, raising costs and lifting the oil price at which a producer can break even.

Rystad’s Abramov said the price to profitably drill a typical well in Texas’s Permian Basin, the nation’s largest producing region, could rise from about $50 a barrel to $55 a barrel next year.

A Federal Reserve Bank of Dallas survey of more than 100 oil and gas producers and oilfield services groups last month found that companies were struggling to find workers and coping with delayed and more expensive deliveries of equipment and materials.

Input costs reported by oilfield services firms were at a record high, the Dallas Fed said, while an index of supplier delivery times almost doubled between the second quarter and the third.

Line chart of Change in past 12 months (%) showing Gains have moderated for oilfield services stocks

More than half of the surveyed oilfield services companies reported difficulty recruiting people, citing applicants who were not qualified or asked for more pay than was offered.

Jeff Wilhelm, a senior vice-president at Flex Flow, a Midland, Texas-based company that provides well-pumping services in the Permian Basin, said he had seen people leave the energy business for good after last year’s crash prompted widespread job cuts.

“I’ve phoned up guys that I’ve known for many years and they’ve said, you know, Jeff, I got out of the energy business and I’ve gone the insurance (job) route or the healthcare route . . . they’re looking for something a little more stable,” Wilhelm said. “That’s disappointing, because some of these guys had 20 to 25 years of experience. It’s hard to backfill that.”

Wilhelm also said that shortages of some specialised rubber, plastic and precious metals products used in the oilfields were forcing companies to postpone work for days or weeks.

The US oilfield service sector was already struggling when the pandemic drove dozens of companies into bankruptcy. While the shares of survivors initially rallied on prospects of a recovery, gains have eased.

Raoul LeBlanc, analyst at IHS Markit, said that while the sector may be able to pass on some rising costs to oil and gas producers, oilfield equipment is still in surplus.

“We still have roughly the same amount of equipment as we did in 2019, when activity was 60 per cent higher than it is now. So there is an abundance of steel — rigs, generators, pumps, trucks — around,” LeBlanc said. “That kit is durable, meaning oilfield service companies have to wait for demand to fully return before they regain pricing power.”

“The immediate problem is finding people to operate them,” he added.

But a prolonged drought of investment in equipment and recruitment could lead to a fresh surge in energy inflation if the industry tries to grow beyond pre-pandemic levels, said Scott Sheffield, chief executive of oil and gas producer Pioneer Natural Resources.

“The capital may be there due to higher oil prices, but the people, the labour, the inventory . . . the equipment, drilling rigs, the frack equipment, it just is not there,” he said in an interview in early October. “So that’s going to be a problem if the world needs us in 2023 to ’25.”