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Low-cost shale drillers could thrive in a higher oil price environment in 2018.
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Earlier this week, OPEC ended months of speculation about the future of its oil market stabilization plan. The current agreement where OPEC and a 10-nation non-member coalition led by Russia are holding back 1.8 million barrels of crude per day was set to expire next March. However, the participants agreed to extend that deal through the end of next year in hopes that it will continue draining off the market's excess supply and prop up oil prices.
That agreement is great news for shale drillers in the U.S. because it suggests oil prices have much more upside than downside. Because of that, low-cost drillers like EOG Resources (EOG +0.01%), Encana (ECA +0.01%), and Marathon Oil (MRO +0.00%) should thrive in the year ahead.
Image source: Getty Images.
OPEC initially struck its accord with non-member nations last November, with that deal set to last through the first six months of 2017. However, it didn't quite have the desired impact on crude prices because shale drillers quickly ramped up, as did Libya and Nigeria, which were the two OPEC members exempt from that agreement. Because of that, OPEC and its partners agreed to extend the deal through March of next year. That extension seems to be working since oil prices have rallied sharply off their bottom in the past few months, thanks to a significant drop in oil storage levels.
With the plan now having the desired impact, OPEC and its partners agreed this week to extend it through the end of next year. Furthermore, Nigeria and Libya have pledged not to increase their output above this year's level. That should help further drain off the market's excess supply. In fact, the concern now is that market fundamentals might tighten too much, which could send crude prices soaring and incentivize shale drillers in the U.S. to drill more wells. Because of that, producers will meet next June to review the deal's impact on prices and oil inventory levels.
At a minimum, OPEC's deal should keep crude around its current levels for the next several months, which is above $58 a barrel for the U.S. oil-price benchmark West Texas Intermediate (WTI). That pricing level is more than enough for top-tier shale drillers EOG, Encana, and Marathon, since each can flourish as long as WTI averages $50 a barrel.
In EOG's case, at $50 oil it can generate the cash flow to pay its current dividend and invest in enough new wells to boost its U.S. oil output by a 15% compound annual growth rate through 2020. In fact, with oil over that threshold this year, EOG expects to increase its production 20% versus 2016's level while living within cash flow. Meanwhile, with crude looking like it will be well above the $50 a barrel mark next year, EOG Resources could grow output at an even more rapid pace or use its growing stream of excess cash to boost the dividend or repurchase shares, which is what several rivals plan to do in 2018.
Meanwhile, Encana can also increase output by a rapid pace at $50 oil. That said, the company's focus going forward is growing cash flow. That was evident in its recently updated five-year plan where Encana noted that at $50 oil it could drill enough new wells to increase cash flow by a 25% compound annual rate through 2022. Furthermore, its current plan would see the company start producing excess cash in 2019, with it potentially generating $1.5 billion in free cash flow through 2022 if oil stays at $50 a barrel. That said, with crude currently well above that level thanks to OPEC, Encana could potentially generate excess cash in 2018.
Marathon Oil, likewise, can excel at $50 oil. At that price point, the oil producer can pull in the cash flow needed to pay its dividend and drill enough new wells to boost output by a 10% to 12% compound annual growth rate through 2021. Because of that, the further crude rises above that level, the more excess cash the company will generate, which would give it the money to accelerate production growth or send more cash back to shareholders.
Top-tier shale drillers are the real winners of OPEC's plan to keep a lid on its production next year. That's because these oil producers have gotten their costs down to the point where they could prosper at $50 oil, which means they can do even better if oil remains at its current level closer to $60 a barrel in the coming year. As things stand right now, Marathon, Encana, and EOG would produce a gusher of cash flow next year, which could provide plenty of fuel to drive their stocks higher.