The Transition from Growth to Value

The headlines are losing their shock value as seemingly each month the U.S. Energy Information Administration releases petroleum production figures showing record U.S. production. Their numbers released last month showed April production exceeding 12 million barrels of oil per day, an all-time high.

Texas, particularly the Permian Basin, drives the trend and the “EIA forecasts that Permian production will average 4.4. million b/d in 2019, a 920,000 b/d increase from its 2018 average.”

Increased production from tight reservoirs is also dampening long-term volatility in oil markets. The Federal Reserve Bank of Dallas looked at the connection between breakeven prices and long-term futures contracts.

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The headlines are losing their shock value as seemingly each month the U.S. Energy Information Administration releases petroleum production figures showing record U.S. production. Their numbers released last month showed April production exceeding 12 million barrels of oil per day, an all-time high.

Texas, particularly the Permian Basin, drives the trend and the “EIA forecasts that Permian production will average 4.4. million b/d in 2019, a 920,000 b/d increase from its 2018 average.”

Increased production from tight reservoirs is also dampening long-term volatility in oil markets. The Federal Reserve Bank of Dallas looked at the connection between breakeven prices and long-term futures contracts.

Their analysis, published May 21, shows a close connection between average breakeven prices and the long-term futures contract for West Texas Intermediate crude. According to economic theory, the long-term futures price should be equivalent to the marginal cost of supply. That is, the price of a future barrel is set by the incremental cost to add another barrel of supply.

In reality, of course, the market isn’t that efficient. But increased supply from shale, enabled by technology advances and production cost declines, has flattened the oil cost curve over the last decade, suggesting that there is significant additional supply available between $50 and $60 per barrel. The upshot is that “there is a much larger amount of supply that can be called into action given a much smaller price increase than in the past.”

Quest for Value

We’re seeing economics in action with production booming. But when you look at U.S. equity sector performance for the first half of 2019, energy ranks dead last.

“The Quest for Value” was the theme of the opening plenary session at last month’s Unconventional Resources Technology Conference in Denver as the speakers described how their companies were shifting from a “production and growth” mindset to one focused on discipline and quality.

The market is going to reward those firms who harness the best people with the best technology to generate enterprise value, said kick-off speaker Mike Henderson of Marathon.

It means being focused and innovative enough to generate durable positive cash flow, not just for a quarter or two, but over the long term, according to Clay Gaspar of WPX. We’re talking about free cash flow – the cash left over after you’ve paid for everything, including your cost of capital. And when you’ve done that, you must then return some of that cash to the shareholder in the form of dividends, share buybacks or debt reduction.

The transition from growth to value is tough, said Peter Hagist of Whiting Petroleum, because there are so many factors at play, including technological, operational and financial variables that can each contribute to or hinder achieving this objective.

Henderson echoed that point, suggesting that working in E&P not only requires specific discipline expertise, but frequently bridging disciplines in order to remain relevant and effective.

As petroleum geologists we must pursue opportunities to learn and grow, to expand our skill sets, to understand how science, technology and business combine to create value.

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