"Drill Baby Drill" won't flood the market with oil

[dan_s]

Notes below are from HFI Research with my comments in blue.

Since Trump won the election, I've seen numerous bad takes on Trump's energy policies. This is especially the case when it comes to his policy of boosting domestic US oil production, "Drill baby drill."

Reality
US shale, namely the Permian, single-handedly saved the world from what would have been a structural oil supply deficit back in 2016, but it won't be able to repeat its success this time around.

What people fail to understand is that while the Federal government could provide tax breaks on capital investments and expedite infrastructure build-out, US shale production has matured and the Permian is not what it used to be. Producers with tier 1 acreages have to manage the long-term value of the assets and this means a slow-and-steady approach to tackling the remaining inventory.

Unlike the old shale days when the name of the game was to grow as fast as you can and sell out, consolidation has already taken place across the US shale patch. With the remaining inventory in the handful of large players, resource management is now the name of the game. There's a reason why producers like Pioneer Natural Resources sold out to Exxon. For all of its criticisms over the years, Pioneer possessed some of the best acreages in the Permian, and Scott Sheffield maximized the long-term potential of the company and gave shareholders an even longer growth horizon (via Exxon's stock).

Another prime example is, one of the remaining pure-play Permian producers. In its latest earnings release, it emphasized its previous commitment to keeping production flat. Instead, Diamondback, following its historic acquisition of Endeavor, continues to focus on cost-cutting and operational efficiency improvements. The improved efficiencies should translate to lower costs and higher free cash flow generation, which will be directed toward shareholders.

But aside from the fact that producers themselves are telling you that growth will be muted, the reality is that the Permian is a maturing basin, and producers are increasingly contending with the issue of a higher gas-to-oil ratio. < Every oilfield, including the shale plays, eventually runs out of Tier One drilling locations, peaks, and then goes on steady decline. The Permian Basin will peak soon, stay near peak production for maybe five years and then go on steady decline.

While this doesn't necessarily prevent oil production from increasing, it makes it much more difficult to get the strong oil production growth of the past. This is another reason why if you look at our real-time US oil production data, US oil production growth has stalled meaningfully since 2022.

Economics
Another incredibly bad take I've seen on Twitter/X so far is the idea that the breakeven for US shale producers is in the $30s. What these people fail to understand is that they are quoting the operating cost or the wellhead breakevens rather than the full cycle economics. < During their conference call, Diamondback stated that their full cycle economics in the Midland Basin is around $37/bbl. At $70/bbl most of their horizontal wells pay out in a year because they come on so strong.

US shale production typically declines ~30% per year so significant capex is required to offset the declining production profile. When you take into account the cost of 1) replacing the production, 2) replacing the declining reserves, and 3) corporate-related expenses, the breakeven balloons to low $50s (for the best producers), and high $60s (for the crappier producers).

This also does not take into account the guidance set out by producers on what shareholders want (dividends + share buybacks). When you factor these things into account, it's not as easy as drill baby drill anymore.

Could higher oil prices change how these companies think about their capex programs? Sure, but then they have to ask a very simple question: what's the best way to maximize long-term value? Is it to grow and then deplete our inventory at a faster rate (higher production depletes inventory faster than lower base production) or is it to keep production at a lower base, but maximize free cash flow generation?

I think the answer is already out there. Just take the time and go read some earnings transcript and you will see that most producers will stay flat for years to come.

Not What You Think
Trump is more bullish for energy stocks than you think. Jon Costello, head of Ideas from HFI Research, published his thoughts on what a Trump presidency means for energy stocks. With fewer regulatory constraints and the end of woke investing, people should quickly realize that shale producers are a lot more disciplined than in the past.

Drill baby drill is not what you think it is. Watch for 2025 guidance from producers to validate what we are saying.
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MY TAKE: Trump can lower U.S. energy cost to consumers by (a) stopping the War on Fossil Fuels ASAP, (b) cutting through the red tape so more pipelines and other infrastructure can be built and (c) ending wars with Russia and in the Middle East. WTI might dip below $70/bbl a few times, but the Right Price for WTI is within the $75 to $85 range, which is where it has been for most of 2024. The actual WTI price averaged $77.60 in 2023 and $77.52 for the nine months ending 9-30-2024.

[aja57]

Appears that Doug Burgrum is going to be running Energy. Any chance Trump and Burgrum would open up drilling on public land, offer oil development incentives with the government collecting royalities on the return?