Rising costs for industry in the oil patch

Dallas Federal Reserve Bank finds inflation hitting oil and gas producers

By Trey Cowan and Clark Williams-Derry January 26, 2022
Courtesy: CFE Media and Technology

The Dallas Federal Reserve Bank polls oil and gas executives in New Mexico, Louisiana and Texas to gauge trends in the region’s energy sector indicate that though oil and gas production is poised to grow this year, the industry faces mounting inflation challenges.

The Dallas Fed reports that its input cost index—all costs involved in producing goods and services by oil and gas support service firms, based—rose to a five-year high of almost 70 during the last quarter of 2021, with about 72% of companies reporting increased costs and only 2% reporting a decline in costs. (The index represents the difference between the percentage of respondents expecting an increase and the percentage anticipating a decrease).

Similarly, the finding and development costs index and the lease operating expenses index both registered the highest readings on record.  Survey responses suggested that input costs could rise by 10%, with almost two-thirds of the sample anticipating even greater cost increases.

The inflation comes on top of rising costs caused by the exhaustion of the inventory of drilled-but-uncompleted (DUC) wells that will force the industry to ramp up drilling over the coming year just to keep output steady. IEEFA has already estimated that total spending on drilling could rise by 8% year-over-year, due solely to the exhaustion of DUCs. Add rapid cost inflation into the mix, and capital spending could rise by almost 20% just to maintain production at the same level as last year.

These cost increases will land first on oilfield service firms—who may not be able to pass the costs on to producers. One survey respondent from the oilfield service sector said the company was still “fighting to get back to acceptable margins for our products and services.” The response suggests that slack demand for drilling and completion, as well as the slow recovery from the COVID-19 pandemic, has reduced the bargaining power of service providers—meaning they could bear a disproportionate share of the cost increases.

Even with these rising costs, about half of oil and gas production executives say they’ll boost output this year. But growth will be uneven: Small producers (fewer than 10,000 barrels per day) were more likely to seek production growth in 2022, while only about a quarter of the large producers singled out production growth as their primary goal. Among larger operators, debt reduction was more popular than production growth. The responses suggest that capital discipline has embedded itself more deeply in the minds of executives at larger companies.

Between rising costs and growing production, capital spending is primed to rise this year. All told, almost four out of five oil and gas production executives surveyed expect capital spending to increase above 2021 levels. Support services executives were almost as bullish, with 72% of the 42 firms expecting capital spending increases this year.

The survey gives hints about greenhouse gas (GHG) emissions trends as well—and, as with production, it reveals big differences between small and large operators. About 48% of executives from large firms said they planned to reduce GHG emissions by more than 5% by 2025, compared with only 24% for small firms. The responses represented an increase from 2021. Even so, pessimism about greenhouse gas targets abound. An overwhelming 95% of oil and gas executives said they doubt countries will be able to meet 2030 commitments for reducing GHG emissions.

The results expose a cognitive dissonance: Many oil and gas executives say that they aim to reduce their own emissions, but almost all of them believe countries will miss their targets. Perhaps this makes sense, given that so many oil and gas executives, especially at small firms, plan to boost drilling this year even as costs are spiking.


Trey Cowan and Clark Williams-Derry
Author Bio: Trey Cowan is an IEEFA oil and gas analyst. Clark Williams-Derry is an IEEFA energy finance analyst.