The world clearly needs more oil and gas, and quick smart. But Opec barely has any more oil capacity, while the European energy majors have guided for flat production numbers for the rest of the year, even as governments and consumers cry out for more supply and management teams roll out the phrase ‘energy security’ again and again.
US president Joe Biden even went to Saudi Arabia to get some more barrels moving – but got nowhere, as Liberum analyst David Hewitt noted: “[Biden gave] the de facto Saudi leader the recognition he wanted, but without securing further production increases from the world’s leading holder of spare capacity”. This week’s Opec meeting could see some more promises but the real tell will be weeks down the line, based on whether members of the cartel can actually find excess supply.
On the gas front, the outage of the Freeport LNG terminal in Texas has tightened supply in both the US and Europe – the closure has stopped some volumes being sent across the Atlantic – as demand soars. The Henry Hub price hit a 14-year seasonal high last week, according to consultancy Rystad Energy, as soaring temperatures increase the demand for gas-fired cooling.
To help calm the market, Biden is also heavily focused on getting more output from his own backyard. Forecasts indicate this should be easy enough. The country is already on track to hit a new record for production next year of 12.8mn barrels of oil per day (bopd), according to the US Energy Information Administration. But the conflict between the government and the oil and gas industry, as well as the relatively minor capital expenditure increases announced by the majors, shows there could be more room to run on this front.
Security or discipline?
Management teams at the largest producers are still keen to underline that most of the record profits are being handed back to investors, rather than plunged into new production. The argument over who is responsible for supply lagging demand has focused on institutional investors and financiers pulling capital from fossil fuel projects, as well as boards refusing to back high spending in fear of flooding the market and causing another downturn for the sector.
Listening to the bosses of US majors Chevron (US:CVX) and Exxon Mobil (US:XOM), it’s clear why fewer projects are being greenlit. Chevron upstream boss James Johnson told analysts last week the company was holding onto ‘discipline’ even with net debt below target levels.
“Our approach to the Permian... for many years has been to be very disciplined, very focused on generating the returns and the efficiency that allow us to be profitable regardless of the prices,” he told analysts.
That doesn’t mean there is zero expansion coming: Chevron put on two new drill rigs in the Permian Basin in July, taking the total number to 10.
But overall the company will likely miss its low-end capital expenditure guidance of $15bn (£12.3bn), according to its outlook from last week. This is at the same time as earnings easily beat forecasts: Chevron reported net income of $11.4bn, against analysts’ forecast of $9.8bn.
Exxon had a similar boon in the June quarter. Its net income was double the previous quarter at $17.6bn and 12 per cent ahead of analyst forecasts. Chief executive Darren Woods pointed to a forecast one-quarter increase in its Permian Basin production for 2022, the second year in a row it would hit this figure. The shale basin, which spreads across Texas and New Mexico, is the key region for the US as it provides around half of the country’s oil output. In terms of production, it is bigger than any one country outside Saudi Arabia and Russia.
“The Permian has become the hot spot for US oil production thanks to significant resources, low breakeven costs and high oil content,” said Espen Erlingsen, head of upstream research at Rystad Energy. “This trend is likely to continue as global oil markets struggle with supply constraints and the demand for oil shows little sign of easing.”
Chevron’s US operations account for 44 per cent of its total sales, while for Exxon Mobil the figure is 38 per cent. The real focus for Chevron and Exxon remains on increasing shareholder returns. "The first financial priority is to grow the dividend," Chevron CFO Pierre Breber said last week. "We've done that for 35 consecutive years, [and] increased it 6 per cent earlier this year. It's up 20 per cent since right before Covid, and it's doubled since 2010."
The majors are still on a business-as-normal footing, with the assumption that oil and gas markets will make their way back to balance. But the managers of the CQS Natural Resources Growth & Income (CYN) investment trust say this is unrealistic. “Many energy producers still appear to discount a 'normalisation' in prices back towards pre-Covid levels, which is too optimistic,” they said.
“Energy prices may stay much higher than discounted for a longer period of time and act as a drag on broader consumer demand and demand for industrial materials.”
Poor service
One easy place to look for answers on growth spending is the services companies. Hunting (HTG) has an onshore-US-focused business, and has tracked the wider industry's share price falls since mid-June as demand destruction concerns emerge. But it has not had the luxury of enjoying a profits surge at the same time, despite reporting an improved order book. Unlike the US or European majors, it is not forecast to see record profits, or even profits equal to those from before the pandemic. Analyst consensus estimates do not have its cash profit returning to 2018 levels ($142mn) in the next three years.
Fellow oilfield services company Baker Hughes (US:BKR) – which analysts see as having much stronger earnings growth than Hunting – said the world would still need more energy even if macroeconomic conditions were to reverse.
"We believe the outlook for oil prices remains volatile, but still supportive of strong activity levels as higher spending is required to re-order the global energy map and likely offsets demand destruction in most recessionary scenarios,” said chief executive Lorenzo Simonelli.
The US majors' capital allocation will have consequences for much of the globe over the coming months and years: the financial world has quickly swung away from backing solely green spending when it comes to the international energy giants. "Company investments in oil and gas are garnering increased acceptance [again], with support for cutting hydrocarbon investments subsiding," said HSBC analyst Gordon Gray.
The UK government has gone for the carrot-and-stick approach to get this moving, encouraging production but also introducing a windfall tax on upstream producers. President Biden has said he would approve more projects, and recent actions back this commitment. But new projects are slow to come online, and the industry and major investors still clearly have jitters around boosting production too much, given their bear market experiences in the past. So profits are funnelled to shareholders – which ultimately creates more of a risk of the regulatory stick coming out in the US, too.
