Common U.S. shale oil myths in the alt-financial media prove deleterious to investors

Shale oil will see massive consolidation over the next five to ten years. The most powerful firms with their low costs of capital will rule.

Note to reader: This article serves as a warning to those who continually underestimate and denigrate the long-term viability of the domestic oil industry. At some level, I have to believe these common refrains get traction in the alt-financial media, because of the alt-financial media’s contempt of everything “American.” This contempt will continue to prove costly to these investors as their macro investment decisions will be placed in opposition of the most likely outcome.

A number of oil firms make billions a year in the United States

Chevron’s and OXY’s competing bids for Anadarko petroleum is just the beginning of a mass consolidation in the shale oil industry as the smaller, poorly funded frackers and drillers will be sold to the well-funded players. Those with access to cheap capital will clean up. These multinational firms will eventually gain an effective control over the entire shale oil sector. These large firms waited until rates of return were attractive enough, given their lower costs of capital, and are now ready to jump on the best independent drillers with their prime real estate.

There are four over simplifications that the alt-financial media make.

  • The assumption that all barrels produced in any particular shale oil region cost about the same to produce.
  • There aren’t many (or any) firms that can make money in shale oil.
  • The U.S. oil industry is built on cheap money and that once the cheap money disappears, the industry will just collapse.
  • Their failure to fully comprehend the differences in the costs of capital between firms. The start up P&E costs in the shale oil regions are relatively small, so there are many small producers with high costs of capital. This tends to drown out the firms with cheaper costs of capital.

Let me explain that these assumptions have proven deleterious to many dollar bears. The worst aspect of this erroneous analysis will be their continual underestimation in the power of the U.S. dollar and the domestic economy.

Exxon Mobil is boosting its projected growth of oil and gas production in the Permian Basin and says the field can be profitable even at lower crude prices.

The Irving-based company said that as soon as 2024 it expects to produce the equivalent of more than 1 million barrels of oil per day in the basin, which straddles western Texas and New Mexico, up from a forecast of 600,000 barrels by 2025.

Exxon has 48 drilling rigs in the basin and plans to raise that to 55 by the end of this year. The oil giant estimates that it is sitting on about 10 billion barrels of oil in the basin.

Its investments in the Permian Basin are expected to produce double-digit returns, even at low oil prices, the company said in a statement. At a $35 per barrel oil price, it said Permian production will have an average return of more than 10 percent.

Exxon is the largest publicly traded international oil and gas company, with $279 billion in revenue in 2018.

Permian power: Exxon expects to produce 1 million barrels a day in top shale play – Dallas Morning News (March 5th)

The old shale oil industry was a money loser, not the new

If we look into the past it seems to be clear that the shale oil industry has not generated any lasting profit, and in fact, we can conclude that including debt servicing costs and bad debt writedowns, the U.S. shale oil industry has never been in the black.

But this is in the rear-view mirror, as the extraction technology continues to improve and the new advances are shared around the existing drillers. As this advancing technology is leveraged and becomes more widespread, the largest oil firms have begun to consolidate their power and exert their control over the entire shale oil industry. Firms such as Exxon, Chevron, and BP, bring much lower costs of capital and cheaper P&E capabilities to the mix.

While the independent U.S. drillers have been cutting spending in response to years of lackluster returns, the oil majors and large independents are expanding in Texas’s Permian region. These large firms are already generating billions in free cash flow a year from domestic production, with much of it coming from the Permain Basin. Indeed, the major oil companies plan to spend about 16 percent more on U.S. drilling and completions in 2019 versus last year, while independent exploration and production (E&P) companies are expected to cut spending by around 11 percent, according to financial services firm Cowen & Co.

Chevron has been producing oil and gas from the Permian since the early 1920s and recently hauled out its five billionth barrel. However, the company estimates that it’s sitting on another 11.2 billion barrels of oil equivalent (BOE) in the Permian, which should provide it with years of growth.

It’s that Permian oil growth engine that makes Chevron such a compelling stock. The company believes that the region will not only supply it with needle-moving production growth but expand its margins and profitability. In Chevron’s view, its Permian Basin position can help fuel 30% compound annual growth in free cash flow through 2020, which would lead its peer group.

EOG generated $1.7 in free cash flow last year; mostly from oil shale.

EOG Resources is probably one of the top producers in the Shale oil region. According to their 2018 earnings press release, EOG produced 430,300 Bopd in the fourth quarter, which was a 17 percent increase to the same prior year period.  EOG generated $2.1 billion of discretionary cash flow and incurred total expenditures of $1.5 billion in the fourth quarter 2018. After considering cash exploration and development expenditures, excluding acquisitions of $1.3 billion and dividend payments of $127 million, the company generated free cash flow during the fourth quarter of $637 million. For the full year 2018 EOG generated a company record $1.7 billion of free cash flow.

COP produced 397k bopd in the lower 48 states for 2018. It produced 436k bopd for 2018 Q4

For ConocoPhillips, the “Lower 48” represents their largest segment based on production – beating out the Asia/Middle East region by about 20k bopd. The company’s large onshore Lower 48 position of 10.3 million net acres, much of it held by production, gives access to scalable, low cost of supply inventory that can generate substantial future production growth. The Lower 48 segment is comprised of two regions covering the Gulf Coast and Great Plains. Their current major focus areas for the Lower 48 include the Eagle Ford, Bakken and Permian trends.

These are just a few of the large firms with low costs of capital that have been and will continue to profitably produce shale oil at low cost and high profit. If we one day do arrive at peak oil, I can bet you that these firms will stand to make a lot more money. Don’t fall into the trap of reading ZeroHedge with its “analysis” of the rising tide of debt writedowns in the oil patch and concluding the whole thing is going to collapse under higher interest rates. This naive approach has come at a steep cost to many followers of the alt-financial media at the absolute worst time.

If you think that high interest rates will be the undoing of shale oil, just imagine how high inflation will be at that point. Either way, the large firms will profit handsomely.