North American onshore: My observations at CERAWeek

CERAWeek posted record attendance numbers this year, and the North American onshore was decidedly the topic du jour. Virtually every conversation referenced the role that unconventionals are playing both at a local, national, and global level.

Here are some observations:

1. 2017 marks a return to the growth game. Companies certainly care more about assuring a return on capital than they did during the heady days of $100 oil. But the fact is that in 2015 investors generally punished independents that pivoted away from growth toward an intentional returns focus, and appear to continue to reward output expansion.
2. Companies that were able to withstand the financial stress and avoid mass layoffs and cuts in capabilities are finding that these tough decisions are now paying dividends as utilization of those human resources, processes, and skills rises along with activity levels.
3. The world is back. After being burned in gas joint ventures and sitting out the downturn, global interest in investing in North American onshore has become widespread and much more serious than even a year ago. Understanding of the system dynamics still lags the reality on the ground by 6 months to a year, but many players are catching up fast.
4. For all practical purposes, capital is not a serious constraint for Permian growth players (a.k.a. anyone with acreage remotely near west Texas and southern New Mexico).
5. US producers are increasingly oil OR gas producing companies. The majority of the larger independents have aggressively re-shaped their portfolios and capital allocation processes to favor oil assets. However, a number of companies - primarily in Appalachia but also in other areas - have essentially doubled down on what they consider to be ultra-low cost gas resources.
6. To misquote The Graduate: "I want to say one word to you. Just one word. Are you listening? Logistics." Nuts and bolts may not be as sexy as geologic discovery, but that was yesterday's victory. The industry has for a long time talked about going into "manufacturing mode" but $100 oil meant that the frantic race to de-risk and define new resources was the primary value-add mechanism. Now the emphasis is squarely on delineating what we have and optimizing the system to handle the enormous complexities, especially in the increasingly crowded Permian.
7. Offshore and international producers are achieving some impressive cost reductions - down to less than $50 - but only on selected projects. The unsanctioned wedge remains enormous.
8. The gyre has turned and now the offshore cost reduction process, which has lagged the onshore adaptation, will start to outpace onshore.
9. Onshore producers continue to claim that 65-90% of the reduction in breakeven prices are structural and irreversible. Service companies (who also see progress within their operations) see the cyclical component exceeding 50%. Both parties cannot be right. For the record, in IHS Markit's view, the data demonstrate that the gains notched to date in overall capital efficiency - from all sources, including service sector costs, high-grading, well design, etc. - are about 55% cyclical and 45% structural. If the upcycle continues, the cyclical elements will unwind over time. However, incremental progress on the efficiency and learning front will continue, tipping the scales toward a majority of gains ending up as permanent (at least until sweet spot exhaustion becomes a reality in the early to mid-2020's).
10. Service companies have clearly started to claw back some price concessions for operations in onshore North America, and the pain is unequally distributed: those most severely exposed are small players that have chosen to rely on oilfield spot markets. That strategy paid off in 2015 and 2016, but such players are usually on the receiving end of the steady stream of news stories about exorbitant price hikes.

So what does all this mean? The discussions at CERAWeek bolstered IHS Markit's opinion that North American onshore supply will ramp quickly out of the gate in 2017, intensifying OPEC's near-term dilemma. And, by showing the market that oil supply has become more elastic due to this new source of supply reactivity, it may cap forward prices. However, the situation on the ground and the incrementally difficult process of scaling up may lead 2018 and 2019 to disappoint those expecting continued large gains to capital efficiency and accelerating production growth.

Learn more about CERAWeek by IHS Markit, including access to a recording of the 'Prolific Permian: Generational perspectives' plenary with Daniel Yergin, Vice Chairman, IHS Markit, Scott Sheffield, Executive Chairman & CEO, Pioneer Natural Resources and Bryan Sheffield, Chairman & CEO, Parsley Energy.

Raoul LeBlanc is Vice President of IHS Markit.
Posted 22 March 2017

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.