North American shale drilling has pretty much exceeded everyone's expectations. What was once a token production source has now become the dominant growth driver of the oil and gas industry. U.S. oil production has more than doubled from its lows about a decade ago to the highest production levels on record. The fast pace of shale growth already sent oil prices into a tailspin from 2014 to 2016, and shale's ability to add 1.5 million barrels of oil per day of production over the past 12 months (!) is a large factor in why oil prices have hit a wall in recent weeks.
What is even more surprising than the growth of this industry is that we could see continued rates of growth in the future. In fact, the CEO of oil services company Halliburton (NYSE:HAL) seems to think that 2019 will be another banner year for the North American oil and gas industry. Here's why he thinks that's a possibility, why he could be wrong, and what investors should make of the situation.
Hitting the pause button
2018 has been a fascinating year for oil prices. At the start, it looked like the oil prices would slowly march higher as inventories cleared, underinvestment in global production reduced output, and the looming threat of Iranian sanctions foreshadowed production shortfalls. Those concerns got clotheslined by U.S. shale output that grew 1 million barrels per day faster than originally anticipated, and then waivers for Iranian oil exports came off the top rope with a flying elbow to wipe out the year's price gains in a matter of days.
Despite these recent pressures, there are still lots of reasons to be optimistic about investing in oil and gas. The decline curve never sleeps, and investment in oil outside North America and select OPEC countries has been tepid at best. That likely means that we will be facing the same issues pushing up oil prices in 2019 that we saw in 2018.
According to Halliburton CEO Jeff Miller, the North American shale industry will be ready to respond. Despite the challenges of finding space in pipelines to move product to market, Miller's statement during the company's most recent conference call suggests that 2019 will be another banner year for shale.
I'm excited about 2019. The catalysts are there for a strong activity rebound. These catalysts are: customer budgets should reload with higher price decks and stronger hedge positions, improving operators' free cash flow and creating additional spending power; the rising DUC [drilled but uncompleted well] count will provide a substantial completions backlog ready to be worked down in 2019; off-take capacity will expand. Our industry is adaptive and creative. This manifests itself yet again in the announced conversion of pipelines in the Permian Basin and new processing capacity in the Marcellus.
We believe that the market will get better in the first quarter of 2019 and sets up for continued momentum throughout the year. We believe that the fourth quarter of 2018 will be the bottom in North America land. I believe this because I see it. I'm already seeing demand from our customers for 2019. They are eager to get back to work. I hear it. I'm hearing this from our business development organization, who are busy responding to inbound 2019 demand. I feel it. I'm feeling customer urgency come back as operators want reassurance our crews will be back out working for them when budgets reset and they restart their full completions programs.
Based on this statement, it would appear that this recent slowdown in the shale patch is short lived and that this quick drop in oil prices will be short lived. Miller isn't the only one who thinks this, either. Halliburton's largest competitor, Schlumberger, said similar things on its conference call as well.
What could go wrong
Considering it's the oil market, pretty much everything could go wrong, because there are always thousands of factors influencing supply and demand of the stuff at any given moment. Since Miller was speaking more specifically about shale drilling in North America, though, let's focus on the things that could keep shale from having another big year in 2019.
The factor that has influenced North American shale the most in recent months has been a lack of pipeline and transportation capacity. Pretty much every pipeline out of hot shale basins like the Permian is stuffed to the gills. While there are plans to build several new pipelines and some of them are expected to become operational in 2019, there is always the possibility that transportation capacity will continue to constrain production growth. After all, it takes much longer to build a 600-mile pipeline than it does to drill a few wells.
What's an investor to do?
With oil prices on a sharp decline and the rest of the market experiencing its own hiccup as of late, it can be pretty intimidating to hit the "buy" button on oil and gas stocks. Looking out over the longer term, though, it's entirely possible that the supply shortage that the market feared earlier in the year could still materialize. Production declines between now and 2021 are likely going to average around 5% annually, which translates to needing more than 4.2 million barrels per day (mmbpd) of new production just to replace existing sources. On top of that, scheduled capacity additions between now and then are only in the range of 1.1 mmbpd to 1.5 mmbpd annually, so there is a lot of additional capacity that shale and other quick-to-respond oil sources need to fill. If they can't meet those large targets, it could lead to tighter supplies and higher prices.
Based on Miller's statements, though, it looks like the North American shale industry is ready to respond. Meeting that much demand would be an incredible task, but 2018 showed us that it can handle incredible tasks without breaking a sweat.