US oil, gas recovery a mixed bag
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"Dear God, just give me one more oil boom. I promise not to blow it next time."

We have heard that before here in Texas — memories of past booms and busts are still fresh. Some of us even remember the 1983 bust when the slogan was, “Stay alive till '85.”

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Then came the double dip of 1986. The impact was profound and protracted as it translated into the collapse of regional banks and real estate.  

There is plenty of news to raise eyebrows these days. Rig counts are growing again, and lease payments are hitting new highs, especially in the Permian Basin in the western part of the state. Venture capital funds are circling over Midland and Odessa.

Skeptics feel like they have seen this movie before and it doesn’t end well. To the extent that activity is based on promised OPEC production cuts, there is reason for caution, given the cartel’s past record. Will the market rebalance in 2017 and establish a new price floor above $50 for West Texas Intermediate oil?

The recent collapse in energy prices was initially met with denial in some quarters, but as it became protracted, the industry responded forcefully with cuts in employment and capital budgets, renegotiation with service companies and a hard look at their balance sheets. 

When prices were in the $100 range a little over two-and-a-half years ago, the goal of most companies was to maximize production, not to worry about increasing costs to acquire acreage, crews, equipment...and debt.

The industry has learned a lot over the last two years as the price sunk and many companies went into bankruptcy or dissolved. All “plays” are not equal, even though most had been profitable during the boom.

Today, companies know more discipline is required in every aspect of the business and more discrimination is needed in selecting the sites for future operations. Even with prices below $50, companies found that there are “sweet spots” that could produce oil with positive cash flow.

However, whether a company was profitable, in the fullest sense of the word, depended on its capital and cost structures. 

Companies found that crews in the field could be trusted to find cost-effective production techniques. Service companies, some with their backs against the wall, accepted “invitations” to lower their own costs to create a symbiotic relationship with their clients. They were in it together.

Costs will rise now and companies will be challenged to remember recently learned lessons. The process will be messy for a while. Service companies will want to restore profitability.

All too often, smaller companies cannibalized equipment to keep operating. Record-keeping was not a high priority. They will have to put Humpty Dumpty back together again.

Crews that were forced out of the industry cover a wide range of personal situations and, the longer the crash continued, the more people went on to new careers. For semi-skilled labor, the relatively high wages of the oil industry will again be a big draw.

For professionals, the situation will be mixed, depending on how stable the recovery is perceived to be and how embedded they are in new positions.

Capital from diverse sources is available for companies with proven leadership and manageable debt. This is not 1986.

Lease payments to acquire rights to land covered a huge range over the years, from a few hundred dollars to tens of thousands. Some were, in hindsight, bad deals that may never recover.

This was especially true for natural gas, where lease payments in the Haynesville Shale hit $25,000 before the gas price collapse. 

The oil industry is still in the learning mode, applying new technology and challenging old models of geology. Most of the new drilling rigs are in the Permian Basin, a very old and productive oil field. 

Apache recently scored big with its massive Alpine High discovery of a reported 15 billion barrels of oil and gas equivalent reserves. What makes this particularly attractive is that much of the acreage was not contested and lease prices were low.

In an MBA class at Rice University’s Jones Graduate School of Business in Houston this past semester, I questioned the logic of today’s lease payments, some of which are reportedly in the range of $38,000 an acre in the Permian Basin.

These executive and professional MBAs, many of whom work for majors and medium-large independent oil companies, pretty consistently said the prices were justified, not based on hope for high prices but on the geology.

New oil formations have been found at various depths, creating opportunities for new production in old fields with vertical drilling. Applying the lessons learned over the past two years, companies may be able to generate positive cash flow and profitability despite high and increasing costs. 

The conundrum is whether this new U.S. production, which will be seen in late 2017, will upset the tentative balance expected in the oil markets. It becomes an expectations game for all players, domestic and international.

The market is always dynamic, with technology, capital, politics and entrepreneurship constantly disrupting the status quo. It’s still too early to tell whether the ghosts of the 1980s will revisit us again.

 

William Arnold is professor in the practice of energy management at Rice University’s Jones Graduate School of Business. Arnold held a White House appointment as senior vice president of the Export Import Bank of the United States from 1983 to 1988, when he received the Distinguished Service Medal.


 

The views expressed by contributors are their own and not the views of The Hill.