Many oil producers started making their drilling plans for 2018 last fall when crude sat in the low $50s, using that price point as their guide. While oil prices have climbed since then, recently hitting the mid-$60s, shale drilling budgets haven't budged, which is a notable shift for an industry that had quickly adapted to changes in crude pricing and cash flow. In fact, in a sign of growing restraint, some shale drillers now say they don't intend to adjust their drilling plans this year even if the cost of crude continues to rise.
From a moving target
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Intense oil price volatility over the past few years led many shale drillers to write their drilling budgets in pencil. After spending just $554 million during a turbulent 2016, Bakken shale-focused driller Whiting Petroleum (NYSE: WLL) initially planned to double its budget last year to $1.1 billion because oil had improved into the low $50s. However, with crude prices sliding back into the $40s by midyear, Whiting cut $150 million out of its budget to better match capital spending with cash flow. It reduced spending even further this year, setting its budget at $750 million so that it could generate some free cash flow to shore up its balance sheet, assuming oil says in the mid-$50s.
The drilling budget of Permian Basin-focused Laredo Petroleum (NYSE: LPI) has also been a moving target over the past few years. In 2016, the company initially expected to spend $345 million on capex but revised it up to $420 million a few months later due to higher oil prices. Last year, the company boosted its budget up to $530 million before adding another $100 million by year-end due to inflating costs and an improvement in oil prices. This year, however, it only plans to spend $555 million, which it can fund with cash flow at $55 oil by year-end.
To set in stone
Laredo Petroleum could spend more money this year if it wanted to because crude is currently in the mid-$60s and it sold its midstream assets last year for $830 million. Instead, it's chosen to pay off $690 million in debt, pushing the total down to just $800 million, while using what's left over -- plus the excess cash it anticipates producing at current prices -- to buy back $200 million in stock. By opting to return excess money to investors and not drill more wells, Laredo joined a growing list of shale drillers that decided to prioritize growing shareholder returns instead of just production.
Others are turning their attention to increasing profitability this year. Fellow Permian peer Parsley Energy (NYSE: PE), which has been one of the most aggressive drillers in the region, said it would not add any more drilling rigs this year even if oil keeps rising. Instead, Parsley "need[s] to execute. We need to get back to firing on all cylinders," according to CEO Bryan Sheffield. That's after his company, like Laredo, got bit by service cost inflation in recent months. After budgeting $1 billion to $1.15 billion for capex last year, spending came in at $1.2 billion because of rapidly rising service and equipment costs. Those quickly inflating expenses will also likely cause 2018 capital spending to be at the high end of its $1.35 billion to $1.55 billion budget.
By holding the line on spending, shale drillers will not only boost drilling returns and their balance sheets, but they'll keep inflation from worsening. They'll also avoid flooding the market with additional oil as they did last spring when they boosted their budgets and activity levels, causing crude to slide back into the $40s by mid-summer. By holding back this production, oil prices are more likely to remain in the mid-$60s, if not head even higher this year. That outcome would provide drillers with more excess cash to pay off additional debt and buy back more stock, which could help drive shares higher.
Holding back to cash in
Shale drillers are resisting the temptation to plow their growing stream of cash flow as oil rises into more wells. It's a smart move considering that increasing spending along with oil has had a negative impact in recent years, especially on their stock prices, since many are down even though crude has risen more than 30%. The hope is that by holding back, shale drillers and their investors will finally enjoy the benefits of improving oil prices.
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