![After a Profitable Year, US Shale Producers Could Face Tighter Margins in 2022-Here’s-Why](/sites/default/files/styles/hart_news_article_image_640/public/image/2021/12/money-rig.jpg?itok=kJw-aiR4)
As production gradually rebounds, the industry will face higher total costs for bringing new wells into production, further boosting capital spending. (Source: Shutterstock.com)
As a result of rising oil prices and lower costs, North America’s oil and gas companies generated a generous surplus of cash in 2021. A closer look at 28 North American shale-focused oil and gas producers shows almost $40 billion reported in revenues during the first three quarters of the year—the highest level since 2014.
However, three converging trends could tighten margins of shale producers in 2022, according to a recent report by the Institute for Energy Economics and Financial Analysis (IEEFA).
Depleting DUC count
The first trend is the depletion of the industry’s DUCs. For several years, operators drilled more wells than they completed. But when global oil prices collapsed in 2020, the industry reversed course, completing more wells than it drilled. As a result, the oil and gas industry rapidly depleted the massive DUC inventory it had built up over the preceding years, the IEEFA analysts wrote.
Using DUCs allowed the industry to cut spending on drilling. The U.S. Energy Information Administration (EIA) reported that domestic producers relied on DUCs for a little more than 1,000 newly completed wells in 2020, and about 2,900 in 2021, saving as much as $10 billion in drilling expenditures over two years.
However, these savings are unlikely to last. The DUC inventory has now reached its lowest level since 2014, according to the IEEFA. The problem is that the industry must always keep some DUCs on hand to schedule their completions efficiently. If drillers want to maintain current levels of production, they may soon have little choice but to increase the pace of drilling, which in turn would mean more drilling rigs in operation and more spending to keep them running.
IEEFA expects some basins to respond to the shrinking DUC inventories sooner than others since DUC inventories vary by region. The Permian Basin, which hosts about half the drilling activity in the U.S. and is also the largest oil-producing region, has slightly less than four months of DUC inventory, or about half its five-year average.
In contrast, the Haynesville’s current DUC inventory of seven months is in line with the region’s five-year average.
Inflation
Inflation is also likely to boost capital spending in 2022. Preliminary data shows that drilling costs have risen 7% since January 2021. Even if costs remain flat for the coming year, the industry will still face higher capital expenses next year compared to the 2021 average.
“Oilfield service costs tend to keep pace with oil and gas prices, so a rapid decline in oil and gas prices could ease price pressures. Yet falling prices would also crimp revenues, hurting the industry’s bottom line,” according to IEEFA analysts.
Increase in well completions
A gradual increase in the pace of well completions may also boost capital costs in 2022. The U.S. oil and gas industry completed an average of 772 wells per month in the first half of 2021, which increased to 868 wells per month from July through November, the EIA reported. As production gradually rebounds, the industry will face higher total costs for bringing new wells into production, further boosting capital spending.
According to the IEEFA, the first two factors—the exhaustion of DUC inventories and inflation—could boost next year’s capital costs by 10% without any change in the number of wells completed.
“Costs will rise still higher if the industry continues to complete more wells. If oil and gas prices fall next year, as futures markets now predict, the oil and gas industry will be pinched between rising costs and falling revenues, jeopardizing its ability to generate cash in the coming year,” the IEEFA analysts said in the report.
Producers kept spending in check even as prices for oil and natural gas rose to their highest level in years. But 2022 could see a reverse trend, with costs rising and energy prices moderating.
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