As U.S. oil and gas production has soared in recent years, so have energy producers' capital budgets. In fact, energy exploration and production spending has grown at double-digit rates in two of the past three years.
But this year, spending is projected to increase by just 3.4% year over year, according to a survey of 300 energy producers by Barclays. With commodity prices still high and oil and gas production continuing to rise, why aren't energy producers spending more this year?
Cost-cutting focus and efficiency gains
There are a few important factors at play. First, energy producers' forecasts for commodity prices this year were quite conservative so they held back on accelerating their drilling programs. They were expecting WTI crude to average just $85 a barrel for the year and natural gas to average around $3.50 per MMBtu. While the latter prediction hasn't been too far off the mark, the former missed the mark by quite a bit; WTI has rallied strongly this year and continues to hover above $100 per barrel.
Second, several energy producers have been relentlessly focused on reining in spending, often at the behest of anxious shareholders. Natural gas producer Chesapeake Energy (NYSE:CHK) is perhaps the best example of a company that has aggressively slashed costs.
In the second quarter, Chesapeake's drilling and completion costs fell 35% year over year, coming in at $1.6 billion, while total leasehold and other capital expenditures plunged 75% year over year, coming in at just $245 million. Not surprisingly, Chesapeake's capital spending this year is forecast to come in at $7.2 billion -- almost half of what it was last year.
Similarly, other companies are cutting costs by improving the efficiency of their operations through techniques such as pad drilling, which allows them to drill the same number of wells using fewer rigs. Consider Pioneer Natural Resources (NYSE:PXD), the Irving, Texas-based oil and gas producer.
In the Eagle Ford shale of Texas, where the company is using pad drilling about 80% of the time, Pioneer has slashed its well costs by an impressive $600,000-$700,000 per well. In the second quarter, it drilled 33 wells and expects to drill 130 wells in total this year using just 10 rigs. By comparison, the company had to use 12 rigs to drill the same number of wells in the second quarter of last year.
Lastly, another reason why companies haven't been spending more this year is due to the lack of transportation and processing infrastructure in some of the leading shale plays across the country. Even in the Marcellus shale, one of the few gassy plays that has seen strong production growth this year, companies continue to be hampered by infrastructure constraints, which are preventing them from bringing some wells online.
In fact, the number of backlogged wells in the Pennsylvania Marcellus jumped to a record 1,546 in the first half of this year, up 8% from the first half of 2012, according to a report by Barclays. Marcellus producers including Range Resources (NYSE:RRC) and Cabot Oil & Gas (NYSE:COG) both cited infrastructure limitations as a constraint on production growth. As of the end of the second quarter, Cabot reported a backlog of 37 wells, while Range said it had 41 wells awaiting completion.
The bottom line
I think the most important takeaways from the North American exploration and production spending slowdown this year is that many companies are relentlessly focused on financial discipline to shore up their balance sheets. They're slashing costs wherever possible, through both efficiency gains and asset sales.
Looking ahead, exploration and production spending is expected to tick up next year, though not at the double-digit growth rates seen in 2010 and 2011. According to Bloomberg, North American producers are forecast to spend about $132 billion next year, about 3.6% more than this year's projection.
Fool contributor Arjun Sreekumar owns shares of Chesapeake Energy. The Motley Fool recommends Range Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.