Persistent cost inflation is putting pressure on US shale oil and gas groups this year, the heads of the sector’s largest producers have warned even as they report record-smashing results for 2022.
Companies such as Devon Energy, Pioneer Natural Resources and EOG Resources that lead exploration in shale rock regions earned outsized profits last year after energy prices soared in the wake of Russia’s full-scale invasion of Ukraine.
Oil and natural gas prices have since slid below levels before the invasion. Costs such as equipment and labour continue to escalate, however, prompting the biggest operators to brace for a smaller cash haul in 2023.
“We’ve seen anywhere between 30 and 50 per cent inflation — depending on which cost category you’re talking about — that’s what we’re walking into in 2023,” Jeff Ritenour, chief financial officer of Devon Energy, one of the biggest shale operators, told analysts on its earnings call.
“I know everybody is tired of talking about it — I certainly am as well,” he said of inflation’s impact.
Over the past two weeks, some of the biggest shale oil operators have reported earnings that dwarfed any previous year, allowing them to shower record returns on shareholders.
Devon’s $6bn in annual net profit more than doubled year on year from $2.8bn. Pioneer’s more than tripled to $7.9bn from $2.1bn in 2021, its previous record. EOG, which reported on Thursday night, earned $7.8bn, up from $4.7bn the previous year.
Despite the cash bonanza, markets were largely unimpressed. Shares in Devon closed down more than 10 per cent the 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 traded 4 per cent lower after market hours late on Thursday after it predicted another sharp rise in wellhead costs in 2023.
Ezra Yacob, EOG’s chief executive, bemoaned a “challenging inflationary environment” as the company estimated another 4 per cent increase in well costs in 2023 after a 7 per cent rise in 2022.
The cost of casing — the pipe used to line wells — has almost tripled over the past year and a half to $110 a foot, according to Diamondback Energy, another big US shale producer. Kaes Van’t Hof, Diamondback’s chief financial officer, told investors this was the “biggest headwind” for the sector.
“I think the headwind is going to ease — if not, it’s a little bit out of our control,” he said.
Morgan Stanley said that while there were signs inflation was slowing in some areas, most management teams were still budgeting for a 10-20 per cent rise in capital spending in the year ahead, biting into earnings.
Rystad Energy, a consultancy, estimated free cash flow — a key industry metric defined as cash from operations less capital expenditure — among shale oil producers peaked at $104bn last year. It anticipates this will fall to about $87bn in 2023 as rising costs drive up spending requirements.
“With oil prices expected to be lower in 2023 and well cost inflation remaining an issue — albeit with the pace of inflation easing — free cash flow will likely be down from 2022 levels,” said Matthew Bernstein, an analyst at Rystad.
Shale groups funnelled unprecedented amounts of cash back to shareholders in the forms of dividends and stock buybacks in 2022, responding to Wall Street demands after a decade of debt-fuelled drilling binges that caused investors to flee the sector.
Pioneer returned more than 95 per cent of its $8.4bn free cash flow to shareholders as chief executive Scott Sheffield boasted of a “fortress-like balance sheet”. It will have less money to return this year: 2023 free cash flow is likely to fall to about $4bn, the company said.
Companies vowed to continue to return funds to investors this year, despite pressure from US president Joe Biden to use the cash haul to drill more to bring down prices at the pump for motorists. Biden has accused the companies of “war-profiteering”.
Bernstein said: “Significant growth is still off the cards for the majority of public shale oil E&Ps, who have continued to set cash return targets over production targets and are not willing to budge from focus on capital discipline.”