The biggest news in the oil patch this week is the fact that oil prices slumped to a four-year low near $80 per barrel before rebounding at the end of the week. The brisk sell-off in oil prices has everyone wondering what impact this will have on the energy sector, especially the U.S. shale boom. So far the CEOs of major oil related companies aren't worried despite oil prices being nearly 25% off their peak earlier this year.
Full speed ahead
Right now oil companies don't expect oil prices to stay low for too long according to Martin Craighead, the CEO of oil-field service provider Baker Hughes (NYSE:BHI). On the company's earnings conference call with analysts, Craighead said that even at $80 per barrel the "returns are quite attractive" so producers are still going "full steam ahead."
These sentiments were echoed by Continental Resources Inc (NYSE:CLR) CEO Harold Hamm in a recent article in the Financial Times. Hamm noted that just two years ago this would have been a problem as producers would have had to drill on leases just to hold those leases by production. Some of those leases would have been unprofitable to drill with lower oil prices. However, today 95% of Continental Resources' leases in the Bakken are held by production, so there is no sense of urgency. It's a similar story at most other U.S. oil companies and because of that these companies can focus drilling capital on the wells that will deliver the highest rates of return at lower oil prices.
When oil prices become a problem
Oil producers can manage $80 oil for a while, but if prices stayed there it would force some producers to cut back a little bit on their growth plans. This was something Pioneer Natural Resources (NYSE:PXD) CEO Scott Sheffield recently noted at a conference. This is no surprise given that his company is planning to spend $3.3 billion this year to drill new wells and for other capital projects.
However, the company was banking on a $100 oil price to fill its coffers with $2.5 billion in cash to drill these wells with the other $800 million coming from cash on hand and asset sales. However, if oil prices stayed near $80 for a year it would erase about half a billion dollars in cash flow. To bridge that wider gap the company would need to either sell more assets and/or cut spending.
That problem would compound when oil prices drop to $70 per barrel and stay there. At that point Pioneer Natural Resources' cash flow would shrink by about a billion dollars. This is why Sheffield said at a recent conference that if oil hit $70 per barrel there would be a "significant cutback" in oil drilling in America. Further, if oil prices fell to $60 per barrel he said that we'd see producers start to shed jobs.
What to make of falling oil prices
America's oil industry can live with oil prices above $80 per barrel. While some producers will cut back spending, most can continue drilling and still make a solid profit. However, once oil prices start to dip to $75 per barrel and stay there for a while is when we'll start to see drillers really cut back on investments. Where things become a problem is when oil prices get into the $60s, which is when America will start to lose energy jobs. While no one is expecting that to happen, oil prices always to seem to have a mind of their own. So, producers are certainly watching the price drop very carefully. No one is worried yet, but no one is taking the plunge lightly either.