Avi Salzman
Two years of enormous gains for U.S. shale-oil stocks could come to a halt in 2023, as rising prices for drilling services and falling productivity for wells slow momentum in the oilfields, according to J.P. Morgan analyst Arun Jayaram.
It would be nearly impossible for the stocks to continue at their current rate. The SPDR S&P Oil & Gas Exploration & Production exchange-traded fund $(XOP)$ is up 150% since the start of 2021. Among the top shale-focused performers over that period were Marathon Oil $(MRO)$, up 346%, and Devon Energy $(DVN)$, up 333%.
Jayaram writes that "the sky isn't falling" for the producers, but making money by investing in them will get incrementally more difficult. He downgraded his overall rating for U.S. producers to Market Weight from Overweight.
"Our ambivalence is largely driven by capital-efficiency concerns from higher oilfield-services costs and initial signs of a deterioration in well productivity in several key U.S. shale basins," he writes.
Companies that provide services for the shale-drillers have been hiking their prices, and producers have been forced to pay up because there's a shortage of equipment and labor to drill new wells. Companies are expecting 10% to 20% inflation rates in services costs, on top of 15% growth in 2022, Jayaram notes. Money these companies spend on services and equipment is money they can't spend on dividends and buybacks, meaning investors could see a slowdown in the growth of shareholder returns.
Oil prices are historically high, lately averaging more than $80 per barrel. But some of the optimism has faded. West Texas Intermediate crude futures, the U.S. benchmark, are in backwardation, meaning that futures contracts expiring soon are trading at higher levels than contracts expiring later. The September 2023 contract is under $80, even though contracts expiring earlier in the year are above $80. In other words, buyers are becoming less optimistic that prices will keep rising.
U.S. producers have continued their cautious stance about drilling. In general, the companies are preparing for another year of slow growth, with the average U.S. producer expected to increase capital expenditures by about 3%. And in general, their wells are likely to become less productive, Jayaram predicts. For the past couple of years, shale producers have been able to grow production by tapping drilled but uncompleted wells (DUCs), without having to spend a lot to drill new wells. But DUCs are getting tapped out, so producers are likely to have to start new projects to achieve the same production.
Jayaram suggests that investors consider companies that have access to other kinds of resources outside of shale, including "explorers and producers with a higher mix of conventional assets (international, deepwater, oil sands)," Jayaram writes. That would include stocks like APA ( APA), Hess $(HES)$, and Murphy Oil $(MUR.UK)$.
He rates APA stock at Neutral, and has an Overweight rating on Hess stock. He upgraded Murphy Oil to Overweight from Neutral, and downgraded Laredo Petroleum $(LPI.AU)$ to Underweight from Neutral. Jayaram still likes some shale names. His top picks are Chesapeake Energy $(CHK)$, Marathon Oil, and Ovintiv $(OVV)$.
Write to Avi Salzman at avi.salzman@barrons.com
(END) Dow Jones Newswires
December 05, 2022 13:31 ET (18:31 GMT)
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