As inflationary pressures intensify, impacts on oil and gas production could intensify
US oil producers on the whole have been reluctant to increase production even as crude prices rise and demand rebounds. They have focused on generating cash flow and have been patient as the economy recovers from the pandemic.
But shortages of supplies needed for drilling and the resulting inflation amid the coronavirus fallout could prolong the trend and keep production under control until 2022. Analysts at Citigroup Inc. said in a June report that inflation could eclipse 12% in the North American oil and gas sector by the end of 2021, driven by rising costs of everything from steel to cement.
Oil prices have recovered from last year’s pandemic-induced slump and have climbed around 40% this year, prompting global producers to rebound in recent months. But the Citigroup team said oil service companies in the United States have had to pay high prices for supplies and are struggling to pass those increases on to enough producers they serve to record a profit. Steel prices for drill pipe used in new wells, in particular, could increase by 50% in 2021, Citigroup said.
If inflationary pressure persists, domestic production could stagnate throughout the year. It could also control the production of associated natural gas – a byproduct of petroleum production – affecting prices just as demand for natural gas increases with the summer heat choking the Lower 48.
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“This supply chain disruption that affects almost every industry could last – maybe until next year – and it’s really a wild card,” said trader Mike Matousek of US Global Investors. He noted that virus outbreaks – and supply disruptions – continue in parts of Asia.
“And inflation in one area of the economy can spill over into another,” Matousek added. “A rapid economic rebound, while good in many ways, could potentially lead to soaring inflation regardless of the pandemic, accentuating this cycle of supply shortages and sky-high prices. “
The US consumer price index jumped 5% in May from a year earlier, marking the fastest rate in more than 12 years, the Bureau of Labor Statistics said Thursday. Part of the increase reflects temporarily low prices in spring 2020. But increases are so large in the energy sector that economists say supply chain disruptions are clearly affecting production costs, contributing to a decline. stable production and resulting in higher costs for gasoline and other petroleum-based fuels. .
Energy prices in May climbed 28.5% per year.
The main challenges include “bottleneck pressures and material shortages,” said Scott Brown, chief economist at Raymond James & Associates.
Excluding food and energy, prices in May rose 3.8% from the previous year. For reference, Federal Reserve policymakers are targeting 2% inflation in a period of healthy economic growth.
Labor costs are also rising, including in energy, as the sector competes with other industries for engineers and other talent in a rapidly recovering labor market, Brown said. US payrolls increased by 559,000 jobs in May alone, according to federal estimates.
The Fed has kept interest rates low – pledging to do so until 2022 to support economic activity – despite rising prices. Fed policymakers have said they believe pandemic disruptions will be sorted out this year and conditions will normalize.
Bankers, however, are increasingly arguing that the Fed may have to raise rates in the face of mounting inflation. Higher rates discourage borrowing and, by extension, spending to help keep prices down.
JPMorgan Chase CEO Jamie Dimon, testifying to Congress at the end of May, said the US economy “is not yet boiling.” But the head of the country’s largest bank said red flags abound and he hopes inflation “won’t get out of whack” and the Fed “will be able to moderate it.”
All of this helps to explain why US producers have reiterated their caution in their talks with investors in recent weeks. For example, Houston-based Marathon Oil Corp. said in May that it would meet its $ 1 billion capital budget in 2021, even if oil prices continued to rise.
“We’re just going to generate more free cash flow and further strengthen our position as an industry leader in capital discipline,” CEO Lee Tillman said on a call to discuss first quarter results, echoing several of his peers.
Assuming a West Texas Intermediate oil price of $ 60 a barrel, the Independent expects to generate $ 1.6 billion in free cash flow this year, he said. Marathon has a mandate to return at least 30% of operating cash flow to investors and is on track to return more than 40% in 2021.
All that being noted, producer activity has rebounded from the depths of 2020. The total number of rigs in the United States stood at 456 as of June 4, according to data from Baker Hughes Co. (BKR). . That was an increase from the 284 platforms operating in the comparable week a year earlier, when virus outbreaks and economic lockdowns were rife.
U.S. crude production for the same week averaged 11.0 million bpd, up 200,000 bpd from the previous week, but slightly below the previous level and far from the 12 level. , 3 million bpd in the comparable week of 2019. Production has hovered around the 11.0 million barrels per day level for most of this year and the EIA expects this that this remains the case.
Globally, however, producers are shifting gears. Forecasting strong demand this summer and through the fall, the Organization of the Petroleum Exporting Countries and its petroleum-producing allies, aka OPEC-plus, are currently executing a three-month plan to increase production through July.
The cartel said it was adding more than 2 million barrels per day during this period. The group expects global oil demand to increase by around 6 million barrels per day in the second half of this year, requiring increased production.
Total global oil demand is expected to average 96.6 million barrels per day this year. OPEC crude demand is expected to reach 27.7 million b / d this year, 5.0 million b / d more than in 2020.
Meanwhile, US commercial crude inventories during the week of June 4 – excluding those in the Strategic Oil Reserve – were down 5.2 million barrels from the previous week. At 474.0 million barrels, inventories were 4% below the five-year average, according to the EIA, reflecting light production and growing demand.
Demand over the four-week period ended June 4 averaged 19.0 million bpd, up 17% from the same period in 2020. However, looking ahead to June, the EIA forecast average U.S. crude production of just 11.1 million b / d in 2021 and 11.8 million b / d next year.