Conventional wisdom used to be that as the major integrated oil companies acquired smaller independents, production growth in the Permian Basin would slow. The same wisdom held that regardless which companies were operating in the Permian and other shale plays, domestic U.S. production would peak in the mid-2020s and then begin to decline.
It’s time to reassess those assumptions.
Bullish projections this week from Exxon Mobil and Chevron on their separate operations in the Permian are rewriting the conventional wisdom about that basins potential.
If what the major integrated companies are saying about the Permian is true, it presents serious questions for global oil markets, particularly for the cartel otherwise known as OPEC. It’s also represents a challenge to future projects in the deep-water offshore, oil sands, the Arctic and other higher-cost basins.
Let’s start with OPEC where the impact could be most damaging. The cartel expects shale growth to “slow significantly” after 2023, causing U.S. output to peak at 14.3 million barrels a day by 2028. OPEC then expects U.S. production to fall to an average of 12.1 million barrels a day by 2040.
That’s a convenient outlook if you’re a member of OPEC. In recent years, U.S. shale has single-handedly been meeting increases in global oil demand, forcing the Saudi-led cartel to curtail production to avoid a price collapse. No doubt the members of OPEC, along with co-conspirator Russia, would prefer to see U.S. production reversed sooner rather than later.
The cartel is not alone in thinking that the dominance of American shale must have an expiration date. The International Energy Agency, the consumer watchdog for developed countries, also sees the market the same way. The IEA expects shale production to plateau in the mid-2020s, ultimately falling by 1.5 million barrels a day in the 2030s due to resource constraints.
After 2025, the “baton gradually passes to OPEC to meet continued – albeit slowing – growth in global oil demand,” according to the most recent IEA long-term outlook.
If this scenario doesn’t materialize, OPEC will have some tough decisions to make, including whether to challenge shale to another price war. The cartel lost the last time it took on shale in 2014. And it started subsidizing U.S. production in late 2016 when it agreed to the production curbs that remain in place today.
Unless OPEC and Russia are prepared to live with the supply cut arrangement indefinitely, the cartel may need to throw down the gauntlet… again. That’s because the data presented this week by Exxon and Chevron, now two of the most significant players in the Permian, paints an extremely rosy picture for the future of the basin, even under lower oil price scenarios.
The two majors are expected to produce close to 2 million barrels of oil equivalent a day combined from the Permian by the mid-2020s, effectively tripling their 2018 output. Chevron plans to increase production to 600,000 barrels a day by 2020, reaching 900,000 barrels a day by 2023. Exxon, meanwhile, expects its Permian production to hit 1 million barrels a day by 2024.
Perhaps more importantly, the Permian has proven to be among the most profitable assets in the companies’ global portfolios.
Exxon analysts say the company’s wells in the Permian are capable of delivering returns of more than 10 percent at an oil price as low as $35 a barrel.
Profit margins are even higher at Chevron, which owns most of its land outright and doesn’t have to pay landowners for drilling rights. “Shale returns are the highest in our portfolio,” said Chevron CEO Mike Wirth, adding they are “north of 30 percent at low oil prices.”
Neither company expects growth to ebb in midterm. “This doesn’t end where our charts end, not even close,” said Wirth, adding that Chevron is not yet recovering “high single-digits” percentages of the hydrocarbon locked in its shale rocks. “If we left 90 percent of the oil and gas behind, it would be a first time in our history.”
Comments like that should serve as a wake-up call to global oil markets. The Permian is not only driving growth for the two companies – Exxon produces a whopping 4 million barrels of oil equivalent every day – it’s also proving to be among their most profitable and robust sources of free-cash flow.
There have always been doubts about shale’s capacity to generate cash. In the early days of the shale boom when swashbuckling independents dominated the plays, growth was the name of the game.
Those days came to an end with the price collapse in 2014, which put investors’ focus back on financial performance and cleaning up messy balance sheets. The current trend of major oil companies expanding and consolidating their shale assets represents the sector’s “third act.” Producers are moving into harvest mode, having already optimized the efficiency of their operations.
And it’s not just Exxon and Chevron, Royal Dutch Shell and BP are also building prominent positions in the Permian. The superior scale and integrated-asset portfolios of the majors make them well situated to handle shale’s challenges, including pipeline constraints, surplus production of associated natural gas, and workforce shortages.
The other advantage the majors hold is the financial resources to invest in pipelines and other midstream infrastructure, as well as new refining and petrochemical capacity to process the surplus of light, sweet crude and associated gas that shale basins generate.
The potential effect of all this on the future investment strategies of the global oil industry should not be underestimated.
If the majors can maintain a low-breakeven cost in the Permian while boosting output, OPEC will need to recalculate but so will other investors in conventional “long-cycle” projects that require longer development times and higher oil prices to be profitable. Deep-water and oil sands operators are hereby put on notice: compete with shale on cost or else.
What’s a realistic forecast for U.S. production? Rystad Energy is probably on point with its prediction that U.S. liquids production will surpass 24 million barrels a day in the next six years at an average U.S. benchmark price of $58 a barrel. But the more interesting question is what happens if U.S. output continues to rise beyond 2025.
Date: Mar 7, 2019