Heading into this year, there was a general sense of optimism in the oil industry. After two challenging years, most analysts expected crude to stabilize in the mid-$50 range as a result of prior under-investment, OPEC's intervention, and healthy demand growth.
However, at the midway point, crude oil is about $10 a barrel below that mark due to weaker-than-expected demand growth and robust output from shale drillers. Further, despite those weaker prices, shale drillers appear unwilling to give up on their growth ambitions, with most planning to maintain their current spending level. That said, while drillers plan to stand firm in the midst of weaker oil prices, the view of the industry is that "we will not drill into oblivion" according to comments by Tim Dove, CEO of Pioneer Natural Resources (PXD 0.07%).
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Releasing a gusher
Pioneer Natural Resources was one of the many drillers that increased its spending and growth plans in 2017. After investing $2.1 billion to increase production 15% in 2016, the company intends on spending $2.8 billion this year, which should boost production 15% to 18% from last year's average. The driller is already off to an excellent start after production rose 3% sequentially in the first quarter, coming in above the top end of its guidance range thanks to robust well results in the Permian Basin.
Bakken Shale-focused driller Continental Resources (CLR), likewise, ramped its spending plans this year. The company budgeted $1.95 billion, up from $1.1 billion in 2016, which should enable the company to increase output 19% to 24% by the fourth quarter compared to its rate in the same quarter of 2016. That said, like Pioneer, after robust well results in the first quarter, Continental Resources is "currently tracking at the top end or better than its annual production guidance" according to the company. Because of that, it said it might boost its full-year production guidance later this year.
These weren't isolated cases. Shale drillers around the country reported expectation-beating production results in the first quarter. Fueling those results were stronger-than-expected well performance due to improvements in the drilling process, such as drilling longer wells and using more sand when fracking. While this increase in well productivity would be great if the market needed the oil, right now it doesn't since oil inventories remain at the upper end of the range for this time of year according to data from the U.S. Energy Information Administration. That overabundance of oil sitting in storage is weighing on the price of crude, which is a signal to the market that it's time to ease up on the gas pedal.
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Not ready to blink
That said, shale drillers aren't yet eager to heed that caution sign because most have the money to continue drilling due to oil hedges and cash on their balance sheet. Further, well returns are still pretty good at current prices. In Pioneer Natural Resources case, it started the year with $3 billion in cash and has enough oil hedges in place to supply it with more than $1 billion in cash flow, even if crude averaged $40 a barrel this year. Meanwhile, the breakeven in the Basin is in the upper $20 a barrel range these days, meaning drillers can make a tidy profit at current prices. That's why Pioneer plans to keep drilling for now. But Dove did say that if prices remain low, it could "pare away," though it still can be a "growth company even in a $45 environment."
Likewise, Permian and Bakken driller WPX Energy (WPX) has no intentions of slowing down at the moment, planning to run 10 rigs this year in a bid to boost its oil output 30%. That's because WPX Energy is just starting out on an ambitious growth plan anchored by its oil-focused shale assets. That plan calls for it to add one to three more rigs next year, which would accelerate its output growth in 2018. That said, WPX Energy did recently hint that it could cut that rig expansion back to zero to three if low oil prices persist.
While drillers are starting to suggest that they could pull back in the future if low prices continue, Continental Resources CEO Harold Hamm seemed to warn the industry that it needs to start pulling back now before those weaker prices become inevitable. He recently told CNBC that his peers should "back up, and be prudent and use some discipline," which is what his company is beginning to do. Otherwise, the industry runs the risk of drilling itself into oblivion by pumping out more oil than the market can handle, which could cause crude to nosedive again.
One way drillers might do that is to drill the wells but not complete them by doing the actual fracking needed to commence production. That was a tactic they used in recent years. For example, Continental ended last year with 187 drilled uncompleted wells in its inventory. With oil running higher earlier in 2017, it ramped up its completion efforts by increasing the number of crews it had working. That said, with crude prices falling, Conventional and its peers could start slowing their completion rate and rebuild their uncompleted well inventories and wait for prices to rebound.
Investor takeaway
At the moment, shale drillers are reluctant to give up on their ambitious growth plans despite slumping crude prices. For the most part, they don't have to abandon those plans because they have the financial flexibly to continue drilling wells that can still make solid returns at current prices in the top shale plays. That said, if crude continues heading lower, drillers will need to begin cutting back either by slowing the rate at which they add rigs or the pace they complete recently drilled wells. That's because the one thing investors don't want the industry doing is drilling itself into oblivion.
