Vantage Point Advisors Energy Blog January 2022

Key 2022 Challenges for Shale Drilling: Higher Costs and a Lack of Bank Financing

Oil drillers in the biggest U.S. fields are shouldering record costs at the same time that some banks are increasingly reluctant to loan money to the sector, according to the Federal Reserve Bank of Dallas. [1]

Equipment, leasing and other input costs for oil explorers and the contractors they hire surged to an all-time high during the current quarter, the Dallas Fed said in a report released on Wednesday.  Costs rose sharply for a third straight quarter.  Among oilfield services firms, the index for input costs increased from 60.8 to 69.8 – a record high and suggestive of significant cost pressures.

Only one of the 44 responding oilfield services firms reported lower input costs this quarter.  Among E&P firms, the index for finding and development costs advanced from 33.0 in the third quarter to 44.9 in the fourth (a 36% increase for the quarter).  Additionally, the index for lease operating expenses also increased, from 29.4 to 42.0. Both of these indexes reached their highest readings in the survey’s five-year history. [2]

Drillers also are seeing the universe of willing lenders shrink in the Eleventh Federal Reserve District that includes Texas and parts of Louisiana and New Mexico.

“The political pressure forcing available capital away from the energy industry is a problem for everyone,” an unidentified survey respondent said.  “Banks view lending to the energy industry as having a ‘political risk.’  The capital availability has moved down-market to family offices, etc., and it is drastically reducing the size and availability of commitments regardless of commodity prices.”

Meanwhile, supply-chain snarls are hindering efforts to replace diesel-burning pumps with cleaner, electric-powered gear in the Permian Basin, where components such as transformers are in “extremely short supply,” another respondent said.

Looking ahead, respondents to the Fed Survey expect a West Texas Intermediate (WTI) oil price of $75 per barrel by year-end 2022 on average, but the responses ranged from $50 to $125 per barrel.  Survey participants expect Henry Hub natural gas prices of $4.06 per million British thermal units (MMBtu) at year-end 2022.

WTI Strip Prices Increase

Spot prices and futures prices for the WTI contract increased by approximately $10.00 per barrel in the near term and approximately $6.00 per barrel over the longer term.

The oil price curve remains in “backwardation” reflecting the market’s expectation of lower future spot prices.

Oil Price Outlook

The price distribution below shows the crude oil spot price on January 4, 2022, as well as the predicted crude oil prices based on options and futures markets. Blue lines are within one standard deviation (σ) of the mean, red lines are within two standard deviations.

Based on these current prices, the markets indicate there is a 68% chance oil prices will range from $61.50 and $92.50 per barrel in mid-April 2022. Likewise, there is roughly a 95% chance that prices will be between $42.50 and $119.00. By mid-June 2022, the one standard deviation (1σ) price range is $57.50 to $98.00 per barrel, and the two standard deviation (2σ) range is $36.50 to $135.00 per barrel.

Key Takeaways

Remember that option prices and models reflect expected probabilities, not certain outcomes, but that does not make them any less useful. If someone asks you longingly if oil will be at $90 per barrel again soon, you now can respond that markets indicate there is about a 16% probability that oil prices are expected to be above that by this April.

For more information, contact:

Gregory E. Scheig, CPA/ABV, CFA, CMA
Vantage Point Advisors
Managing Director / Energy Practice Leader
Certified Mineral Appraiser
180 State St., Suite 225, Southlake, TX 76092

214.254.4801

gscheig@vpadvisors.com

 

[1] EnergyNow.com, Shale Drillers Face Record Cost Pressures as Banks Shun Sector, December 30, 2021, https://energynow.com/2021/12/shale-drillers-face-record-cost-pressures-as-banks-shun-sector

 

[2] Dallas Fed Energy Survey, Fourth Quarter, December 29, 2021, https://www.dallasfed.org/research/surveys/des/2021/2104.aspx#tab-report