I Can See Clearly Now - E&Ps Slow Capex Growth Amid Talk of Cost Deflation in 2024

Rapidly rising prices for goods and services have plagued the economy since the onset of the pandemic — and led the Federal Reserve to ratchet up interest rates to help cool things off. Despite strong signs that overall inflation is receding, the negative impacts are far from over. Like every other sector, the U.S. E&P industry faced soaring costs as it struggled to restore production after widespread shut-ins in the spring of 2020. However, in recent Q2 2023 earnings calls E&P executives provided guidance that suggested that costs had not only plateaued but might actually decline in 2024 and beyond. In today’s RBN blog, we discuss updated 2023 capital spending guidance for U.S. oil and gas producers and their early outlook for 2024 investment.

After the pandemic-induced plunge in crude oil prices in early 2020, the 42 E&P companies we monitor — every publicly held U.S. E&P with a market cap of over $500 million — slashed capital investment by 50% to just $34 billion to conserve cash. Despite an oil-price recovery, E&P spending inched up only 6% in 2021 to $39.1 billion. However, 10% to 20% inflation in oilfield goods and services combined with the need to boost the inventory of drilled but uncompleted wells (DUCs) after a steep pandemic drawdown drove a 24% increase in initial 2022 investment guidance to nearly $50 billion. As we said in our blog Take It Easy, sustained high commodity prices allowed producers to increase drilling to offset steep shale decline rates, sending their capex guidance up 4% in both Q2 2022 and Q3 2022, then accelerate another 12% in Q4 2022. The result was total 2022 expenditures of $60.1 billion, up 54% from the previous year and the largest year-over-year growth rate in over a decade.

Initial 2023 capital guidance released by the companies we cover revealed a 17% increase to $70.7 billion, just 3% below pre-pandemic (2019) investment of $72.9 billion. The increase largely reflects a combination of inflation and increased organic capital outlays related to acquisition activity. However, our analysis of first-half 2023 reports shows that growth has been scaled back from initial 2023 guidance, with the most recent capital spending guidance down a smidgen at $70.7 billion (multicolored bar to far right in Figure 1, left axis). It’s tempting to attribute part of the dampening of investment to a recent jump in the reinvestment rate — the percentage allocated to capital spending — from an all-time low of 39% in 2022 to 76% in Q2 2023 because of declining cash flows from lower commodity prices. But as we said in our recent Bottoms Up blog, higher Q3 realizations are brightening the outlook for rising profits and cash flows. Instead, E&P managements indicated in their recent earnings calls that the major factors influencing spending were increased capital efficiency and, most importantly, a strong positive (i.e., downward) trend in the costs of oilfield goods and services.

The word that dominated those conference call discussions, most often raised by analysts, was “deflation.” While some E&P executives embraced the word and others danced around it, there was general agreement on a pronounced softening in the cost of oilfield goods and services. ConocoPhillips was among the most direct respondents, citing deflation in their Lower 48 assets. Management specified lower costs for tubular goods, chemicals, sand and proppant and discussed declining rig rates for new contracts it partially attributed to a decline in gas-focused drilling. EOG Resources and Devon Energy also indicated they were clearly seeing deflation. Permian Resources, which recently announced the $4.5 billion acquisition of Earthstone Energy, said it was seeing 10% deflation in drilling costs per lateral foot and a 5%-7% decline in overall costs. Diamondback Energy was more cautious, indicating it was “premature” to call recent cost trends deflation, but it did point out a reduction in drilling, completion, and equipment cost per lateral foot from the low $700s at the beginning of 2023 to an estimated low $600s by the end of this year. Producers like Marathon Oil, Occidental Petroleum, and Vital Energy had yet to incorporate deflation into their future projections, but were organizing to capture cost reductions as they took place.