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Oil Production Faces Ongoing Headwinds

Published 29/09/2022, 10:11
Updated 09/07/2023, 11:31

The Federal Reserve Bank of Dallas' third quarter energy survey was released yesterday (Sept. 28). It provides an interesting look at oil and gas production in the most productive onshore region in the United States.

The survey revealed that inflation and supply-chain delays continue to play a major role in hampering production and expansion. The cost of doing business increased for the seventh straight quarter. These include operating expenses, exploration and development costs, and input costs for oil services. Firms also reported the time to receive materials and equipment remains well above average. Supply chain issues are improving, but significant delays remain problematic for oil and gas operators.

Despite these headwinds, firms continued to expand their operations, though at a slightly decreased pace from the previous quarter. Oil and natural gas production continued at essentially the same pace as last quarter.

Most of the executives who responded to the survey seemed positive about the price of WTI for the remainder of 2022. The majority expect crude oil to stay within the $80-$100 per barrel range. 85% also expect the oil market to tighten considerably by the end of 2024, particularly given the current environment of under-investment in new oil resources. 79% of executives also expect that financial investors will return to the oil and gas sector after being scared away by the ESG movement and poor returns. It is particularly significant that executives from exploration and production firms believe that the oil market will tighten, and investment will return.

These two elements may seem contradictory, but traders should understand that although high prices will entice investment in oil and gas, new projects will take longer to come online than they previously did in the shale patch. Many easy-to-access shale oil resources are being exhausted and the regulatory environment in the U.S. adds significant time and money to the process. In addition, growing global demand for oil, along with the prolonged period of low investment, means that so much new investment is needed to overcome the deficit. Even when production is growing at a healthy rate, prices will likely remain elevated.

One recurrent theme expressed in the comments section, was the extent to which federal policy is hampering oil and gas production. For example, one executive explained that the Environmental Protection Agency (EPA) is trying to label the entire Permian Basin as “non-compliant” based on “one air sampling station outside Carlsbad, New Mexico.” Another mentioned “weaponizing and undermining of the U.S. Bureau of Land Management leasing and Gulf Coast licensing rounds” as a roadblock for the entire oil and gas industry in the U.S. One oil services company explained that they have usable equipment that is in demand, but it is currently idled because they aren’t able to obtain specific emissions parts mandated by the government to control emissions.

A second recurrent theme was uncertainty, but not just due to regulatory changes. Extreme volatility in commodities prices is making it very difficult for firms to employ strategies like financial hedging to offset risk. The Federal Reserve’s monetary policy is causing a great deal of uncertainty for drillers because if the economy plunges into a recession, demand for oil will fall. Oil services firms are uncertain whether they will be able to access the capital they need to redeploy and upgrade equipment, because they are not getting long-term contracts that make these expenses advisable.

Even though oil production has increased markedly in the U.S., traders should keep abreast of the trends and concerns that businesses in the most productive region of the U.S. are facing. These issues indicate that traders should not assume the current resurgence in production will last. It is likely that it is already slowing down even if we aren’t yet seeing that in the production data.

For more insights from the third quarter energy survey, tune in to the Energy Week podcast on Tuesday, October 4 when my co-host and I will be speaking with Kunal Patel, a Senior Business Economist in the Research Department at the Dallas Fed and an architect of the survey.

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