Home Commodities US shale oil groups’ record profits are threatened by cost inflation

US shale oil groups’ record profits are threatened by cost inflation

by SuperiorInvest

Persistent cost inflation is putting pressure on US shale oil and gas groups this year, the bosses of the sector’s biggest producers have warned, even as they report record results for 2022.

Shale exploration companies such as Devon Energy, Pioneer Natural Resources and EOG Resources made huge profits last year after energy prices soared in the wake of Russia’s sweeping invasion of Ukraine.

Oil and natural gas prices have since fallen below pre-invasion levels. Costs such as equipment a work however, it continues to escalate, forcing the largest operators to prepare for less cash in 2023.

“We’ve seen anywhere between 30 and 50 percent inflation — depending on what cost category you’re talking about — that’s where we’re going in 2023,” Jeff Ritenour, chief financial officer of Devon Energy, one of the largest shale operators, said analysts on their earnings.

“I know everyone is tired of talking about it – I certainly am too,” he said of the impact of inflation.

One of the biggest in the last two weeks shale oil operators reported profits that exceeded the previous year, enabling them to achieve record shareholder returns.

DevonAnnual net income of $6 billion more than doubled year-on-year from $2.8 billion. Pioneer’s more than tripled to $7.9 billion from $2.1 billion in 2021, its previous record. EOG, which reported Thursday night, earned $7.8 billion, up from $4.7 billion a year earlier.

Despite the cash bonanza, the markets were largely unaffected. Shares in Devon closed up more than 10 percent a day after its earnings report revealed higher-than-expected capital spending to cover production costs at the end of 2022 and the company said spending would rise by another third in 2023. EOG was trading 4 percent lower in after-hours trading late Thursday after forecasting another sharp rise in well costs in 2023.

Ezra Yacob, EOG’s chief executive, complained of a “challenging inflationary environment” as the company estimated another 4% increase in well costs in 2023 after a 7% increase in 2022.

According to Diamondback Energy, another major U.S. shale producer, the cost of casing — the pipe used to line wells — has nearly tripled to $110 a foot over the past year and a half. Kaes Van’t Hof, Diamondback’s chief financial officer, told investors it was the “biggest headwind” for the sector.

“I think the headwinds will ease – if not, it’s a bit out of our control,” he said.

Morgan Stanley said that while there were signs of a slowdown in inflation in some areas, most management teams were still expecting a 10-20 percent increase in capital spending next year and biting profits.

Consulting company Rystad Energy estimates that free cash flow — a key industry metric defined as cash from operations less capital expenditures — among shale oil producers peaked at $104 billion last year. It expects that to drop to about $87 billion in 2023 as rising costs increase spending requirements.

“With oil prices expected to be lower in 2023 and good inflation continuing to be an issue – albeit at a moderate pace – free cash flow is likely to be lower than in 2022,” said Matthew Bernstein, analyst Rystad company.

Shale groups returned an unprecedented amount of cash to shareholders in 2022 in the form of dividends and share buybacks, responding to Wall Street demands after a decade of debt-fueled drilling that drove investors away from the sector.

Pioneer returned more than 95 percent of its $8.4 billion in free cash flow to shareholders as CEO Scott Sheffield boasted a “fortress-like balance sheet.” It will have less money to return this year: free cash flow is likely to fall to about $4 billion in 2023, the company said.

The companies have vowed to continue returning funds to investors this year, despite a push by US President Joe Biden to use the cash for more drilling to lower pump prices for motorists. Biden accused companies of “war profiteering“.

Bernstein said, “For most public shale oil E&P companies, which continue to set cash return targets above production targets and are unwilling to back away from a focus on capital discipline, significant growth remains elusive.

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