US oil production has rebounded from its Covid-19 lows, but now seems to be bumping up against significant constraints that will limit further growth. Despite strong oil prices, US drilling and fracking activity has flatlined since mid-June, with the oil rig count stuck at about 600. Several market impediments have emerged, while a dramatically changed shale industry, now laser-focused on cash returns, is behaving much differently than before the pandemic. Some experts are scaling back previously aggressive production forecasts. Decent growth is still likely for the next couple of years, but the sector could then stall. Back in April, the US Energy Information Administration (EIA) had expected the US to add 800,000 barrels per day in crude production this year for an average of 12 million b/d, and another 900,000 b/d in 2023. Others predicted growth as high as 1 million b/d this year. These are now being cut back to more modest numbers. Energy Intelligence, by contrast, has consistently forecast the US would add 600,000 b/d this year to average around 11.8 million b/d, followed by a gain of 750,000 b/d in 2023. After recent revisions, the EIA’s forecast is now in line with this. Such growth is still impressive, particularly after US output dropped below 10 million b/d at the height of the Covid-19 pandemic in 2020. In addition, the US will add about 450,000 b/d in natural gas liquids (NGLs) this year and roughly the same amount in 2023, with NGLs output expected to exit 2023 at 6.6 million b/d, according to our forecast. Taking into account all liquids, the US remains a force in global supply in the near term.
Supply chain issues, labor shortages, inflation and infrastructure constraints continue to dog US producers after surfacing during the post-pandemic recovery last year. Today, firms also face extreme oil price volatility and the growing threat of economic recession, which could hurt oil demand. Despite global supply tightness, there seem few reasons for shale producers to grow more aggressively. Publicly-traded firms are holding the line regardless of oil market signals — they did not meaningfully change investment plans when West Texas Intermediate (WTI) breached $80 per barrel in late 2021, nor after the Ukraine war pushed WTI to $120/bbl earlier this year. The subsequent fall in prices, with WTI now back under $85/bbl, makes accelerating growth and depleting drilling inventories even less likely, especially considering uncertain demand. Shale executives say that, even if they wanted to expand faster, tight capacity for oil services would make it almost impossible.
Shale’s embrace of capital discipline and cash returns is well-documented. But after years of investor pressure, the ethos is now fully baked into the sector. Executive pay is now tied to financial returns, ensuring that managements stick to the low growth model. Investors still question the sustainability of shale's recent strong returns, while rampant consolidation has put more production in the hands of fewer, larger players — making it easier for Wall Street to exert its influence. Pioneer Natural Resources’ executive compensation plan reflects shale's new priorities. For 2021, it was 40% weighted toward corporate returns and free cash flow, 20% toward environmental, social and governance (ESG) and health and safety, 20% toward capital spending and cost control and 20% toward annual strategic goals. That is a big change from 2019, when Permian Basin production and reserves growth (25%) and drilling and completion activity (12.5%) factored heavily. The majors and super-independents that now dominate shale after waves of mergers and acquisitions have created a more oligopolistic sector. These financially-focused firms are less likely to break ranks on low growth.
Longer term, there remain questions about the economics of shale, as well as the scale and viability of the resource. Energy Intelligence reckons that shale’s per barrel free cash flow breakeven costs are in the $60s rather than the $30-$40 range that companies advertise. US production should slightly exceed the 13 million b/d pre-pandemic peak achieved in late 2019, according to our forecast, but this would not happen until late 2024 — and upside could be extremely limited from there. Back in 2018, shale pioneer Mark Papa spoke of “resource exhaustion,” arguing shale would not grow past 2025 because of inventory degradation. This has since become more the consensus view. At the recent Barclays CEO Energy-Power Conference, Pioneer CEO Scott Sheffield said some operators had started drilling in less productive Tier 2 and 3 acreage. The industry is believed to have exhausted much of its best acreage and drilling inventory during the downturn. A drop in well productivity could lead to more challenging extraction, higher breakevens and less incremental drilling, which add further pressures on US output growth.