The new coronavirus could very well tip the world into a recession. It has already pushed air travel into a major slump and left industrial activity mired in a slowdown. With an already oversupplied market, oil prices have plummeted to the $30 level. It was hard for oil companies to turn a profit when oil was in the $50 range; it's even harder now. Oil companies the world over are starting to pull back on their drilling efforts. But that's not why ExxonMobil's (XOM 3.61%) U.S. production growth is destined to slow. Here's a deeper dive into the issue and why you need to understand the subtleties of Exxon's onshore business before jumping to conclusions.
The coronavirus hit
There's no question that COVID-19 has been a disaster for the energy sector. And it will likely get much worse before it gets better, with countries around the world telling people to stay home (or demanding it!), travel being curtailed, and general economic growth grinding to a halt in the most affected regions. China, one of the largest economies in the world, was the preview of what could happen on a global scale. And even that giant nation's recovery won't be enough to offset the hit to the world as COVID-19 spreads rapidly around the globe.
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Since oil is a cyclical business driven by economic ups and downs, oil prices are likely to see continued downward pressure from COVID-19 until the illness is better contained, or at least better understood. And, at the same time this is going on, OPEC and Russia are in the middle of a price war. Neither wants oil to be as low as it is today, but they can't agree on production cuts to prop up the price. The real issue here, however, is U.S. onshore production, which has been ramping up swiftly in recent years. Every time OPEC cuts production, U.S. production basically picks up the slack. And every time oil prices rise, increased U.S. production puts a lid on the uptick.
The real goal of the OPEC/Russia spat is to push weaker U.S. producers out of the market. COVID-19 is making that even easier, since it's putting further downward pressure on energy prices. With that backdrop, you'd expect a giant U.S. oil driller like Exxon to pull back on the rapid growth of its onshore U.S. energy program. Its onshore growth is going to slow, but it's a more complex issue than it seems.
Large numbers
In 2019, Exxon's U.S. shale production increased an incredible 79% over 2018 levels. That growth helped push the oil giant's full-year production higher by around 3%, the first uptick in several years. And it's still early days for a region for which Exxon has very big plans. In fact, by 2025, it hopes to at least double production from current levels.
Moreover, Exxon is openly making the choice to invest counter cyclically. It is well aware that oil prices are weak today, and it is using the downturn to upgrade its portfolio at what it believes will be advantageous prices. In fact, the company estimates that onshore drilling is about 25% cheaper today than it was roughly five years ago. Offshore drilling is even cheaper, with costs falling by more than 50%!
That helps explain why Exxon is still planning capital investment spending of as much as $35 billion a year through 2025. To be fair, the COVID-19 scare could lead to a pullback in Exxon's plans, but it is unlikely to lead to a massive decline. That's because the company believes the long-term supply/demand outlook remains favorable for higher oil prices. It isn't the only oil major that believes oil is here to stay.
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However, even if Exxon continues to push on in the U.S. shale space, its onshore U.S. production growth will start to slow. That's because an 80% growth rate is unsustainable. At that rate, production from the region would double every 1.1 years or so. Trees don't grow to the sky, and neither does oil production growth. Exxon's onshore production will likely continue to expand, but production growth will decline over time even as total output continues to rise. It's simple math -- as the denominator (total production from the region) gets bigger, the growth rate will start to slow.
And yet the oil giant really can't stop drilling in the onshore space because of the nature of the wells. Shale wells are relatively quick to drill. However, production tends to fall off more quickly than other wells, like those Exxon is building in offshore Guyana. The oil giant is using its shale effort to keep production up while it works on longer-term projects, essentially bridging what would otherwise be a production gap. And it can't stop drilling because the onshore U.S. wells start to slow down relatively quickly. COVID-19 may lead to a pullback in shale drilling, but it is highly unlikely to materially curtail Exxon's efforts in the region. That's doubly true when you look at the oil giant's robust balance sheet -- which allows it to invest even during market weakness.
The big picture
Exxon is committed to the onshore U.S. space because it needs the fast production offered by the region. However, the rapid growth it has seen in shale can't be sustained for long because of the math involved -- growth will continue, but percentage increases will fall over time. COVID-19 clouds the outlook for all energy companies and could lead Exxon to pull back on its drilling plans. However, before you assign blame to COVID-19 for any slowdown in the growth of Exxon's U.S. onshore production, step back and look at the entire view of the situation. Growth was destined to slow from the rapid levels seen in 2019 regardless of the coronavirus, and Exxon really needs the U.S. production to keep its numbers up while it waits for production from other investments to come online. COVID-19 is an important issue in the mix here, but it is hardly the only one.
