Monday was an unprecedented day in the oil market. Over the weekend, enemies of Saudi Arabia conducted a drone attack on key parts of the kingdom's oil infrastructure, halving its production output. The damage to its crude-oil processing facilities cut the global supply by about 5%, making it the most significant disruption in the market's history.
Unsurprisingly, crude prices spiked. The U.S. oil benchmark, West Texas Intermediate (WTI), surged more than 15% to nearly $63 a barrel, its largest one-day gain in a decade. Meanwhile, Brent, the global crude oil benchmark, surged almost 20% at one point, its biggest jump ever.
Despite that monster rally in crude prices, and the uncertainty around when Saudi Arabia's output will return to normal levels, oil companies elsewhere aren't planning to ramp up their drilling activity -- yet. Instead, they're waiting for more clarity on the situation.
Image source: Getty Images.
The wait-and-see approach
The CEOs of several U.S. oil companies have commented on the recent spike in crude prices, and their general sentiment is that it won't cause them to change their plans. Scott Sheffield, CEO of Pioneer Natural Resources (PXD +0.00%), for example, told The Wall Street Journal, "there will be no intention to add rigs over and above our original plan." As such, the company will stick with its $3.05 billion to $3.25 billion capital budget. Pioneer's current budget range is $100 million lower than it initially planned for, thanks to efficiency gains this year. The company was easily able to fund that budget through free cash flow prior to this oil price spike. So management would prefer to use the incremental profits from higher crude prices to repurchase more of its stock, rather than drill more wells.
Similarly, Chevron (CVX 2.83%) CEO Michael Wirth told CNBC that it's too early for the industry to boost spending in response to higher oil prices, because the market's fundamentals haven't yet changed to justify such moves.
Most oil executives don't anticipate this attack having a long-term impact. Saudi Arabia has said it expects to be back at full capacity in a matter of weeks. In addition, the oil market had more than enough supply before the event, as well as reserves, and there doesn't seem to be a need for more production to fill the gap.
Image source: Getty Images.
What might cause them to change their mind?
The market has enough crude oil in storage to make up for Saudi Arabia's lost output in the near term. However, it can't cover the shortfall forever. If it takes Saudi Aramco more than a few weeks to repair its facilities, oil companies elsewhere might need to rethink their plans. Meanwhile, the greater concern revolves around how Saudi Arabia might respond. If it retaliates against Iran, the country it believes is behind the attack, the ensuing open conflict could engulf the entire region, which would likely cause even more significant disruptions to the oil market.
If oil producers find that available supply isn't in balance with demand, they'll respond by completing more wells. Many U.S. drillers have built up significant inventories of drilled but uncompleted wells that they can quickly finish. Concho Resources (CXO +0.00%), for example, adjusted its operating plans during the second quarter due to slumping oil prices, reducing its pace of well completion. With the largest part of the work done on those wells, however, Concho could have them pumping out crude rapidly if the economics of the industry shifts.
Meanwhile, oil companies can also increase the number of rigs they have drilling additional wells. Many have an extensive inventory of locations that aren't worth exploiting at lower oil prices. Devon Energy (DVN 3.94%), for example, has 4,200 locations that can earn high returns at $50 oil. Those sites are enough to last it 15 years at its current pace. However, it has another 2,300 locations where it only makes economic sense to drill when crude oil is above $60 a barrel. Devon could start tapping some of these second-tier locations if an undersupply of oil pushes prices into that range.
Preaching patience for now
Oil industry executives don't want to overreact to this price spike, especially assuming that their view is correct and the disruption is a short-term event. By remaining patient, oil companies can cash in on the higher crude prices, and bank more money to pay down debt or buy back stock. However, if oil prices keep climbing due to delays in getting the crucial Saudi Aramco facilities back to full capacity, or due to an escalation of conflict in the region, expect producers elsewhere to respond.
