Shale Executive Bryan Sheffield, son of Scott Sheffield (former President of Pioneer Natural Resources) made sure they was no need for interpretation in his recent remarks. “The industry needs to cut immediately and hunker down to let the tariff war play out”, Sheffield said, as Brent crude hovers below $60/bbl (a 4-year low) and WTI seems stuck at about $3 less. Sheffield reportedly said his Formentera Partners LP would “delay drilling” and shift focus to already established short-term drilling contracts and would only concentrate more on expanding the company’s uncompleted wells “once the market stabilizes”. He described the current situation in the oil industry as being a “blood bath”.

Tariffs or Trade Wars?

Neither Trump nor Chinese leaders show any signs of backing down from tariffs which are being described as a “trade war’. Oil prices were further dinged (substantially) by OPEC’s decision to increase production for the second consecutive month, raising output for the upcoming month by over 400K barrels a day and returning to market 2.2M barrels per day between now and November. As per Reuters, expect “speedy hikes in July, August, September, and October”. Trump is set to visit Saudi Arabia in the coming weeks to discuss an arms package and a nuclear agreement. Ironically, he also plans to ask the Saudis to pump even more oil to counter inflationary pressures at home.

The Politics of the Situation….

Unconventional producers made very significant donations to Trump’s election campaign and played a huge role in the “Make America Great Again” slogan by using aggressive exploration techniques and becoming the top crude producer in the world. Recently, they have expressed displeasure over its high level of support for the new administration, which has since caused a severe oil price plunge despite promises of a future where shale drillers could “drill baby, drill”. Betrayal is a strong word, but it has been recently heard more and more among industry executives.

The troubles began almost immediately upon Trump’s 4/2 announcement to implement a swift 10% tariff on all imports, effective 4/5, with the promise of targeting specific counties on 4/9. Since then, there has been too much back and forth to report here, including a historic stock market plunge, since reversed by the single largest one-day gain in NASDAQ history.

New Energy Secretary Chris Wright seemed totally unphased, calling happenings in the oil patch “pretty much business as usual”. He called the stock market selloff “overblown” and fears about the global economy “misplaced”. Further, he referred to a “market place right now that is worried about economic growth. I think that fear is misplaced”, he said, using what is apparently one of his favorite expressions regarding the entire situation.

I am of the opinion that everything will settle down shortly and that the US will find itself in a better trading position across the board. Oil traders always think the sky is falling and, expecting the worst, have significantly cut back their position in oil. They claim to anticipate demand to plunge because of the tariffs on consumer spending, inflation and, consequently, economic growth. One could say with little argument that the selloff of oil stocks was overblown in light of the long-term outlook for oil demand, which is undeniably bright. Long term views, however, rarely affect commodity markets, whose investors seeks to predict the short-term ups and down of oil (and other commodities) pricing. I’d further offer that the huge rebound made by the stock market (and in a very short time period) is further proof of overreaction by speculations.

The Economics of Shale Drilling

Gabelli Funds analyst Simon Wong offers that “We need to wait and see what happens over the next quarter or two. I don’t expect drastic changes if WTI falls below $60 and quickly rebounds. However, if WTI falls below $60 and stays there for two consecutive quarters, I would expect US E&P producers to start lowering capital expenditures and defer production. US production will still likely grow at or around $60, stay flat around $58-$60, but start declining under $55”.

While many smaller US shale companies may struggle to maintain profitability at oil prices below $50/bbl, the larger companies operate more efficiently making lower break-even costs and allowing profitability at lower oil prices. Other factors such as basin location and the age of the wells must be taken into effect. Typically, the larger drillers will have lower drilling costs at least partially due to economies of scale.

The cost to explore and produce unconventional reservoirs varies greatly from one play to another. Canadian oil sands are almost $10/bbl less expensive than typical US shale wells. Argentina has a particularly affordable shale formation called the Vaca Muerta Shale, which breaks even as low as $40/bbl. As for the US, the Eagle Ford has a break-even price of about $26/bbl while the Permian requires $45/bbl or more. On average, shale formations in the US lower 48 require $60-$65 per barrel, depending on, among other things, the age of the well. In terms of profitability, however, the numbers look different. The oil price range for drilling a well (and making a profit while doing so), starts at $61/bbl and ends at $79/bbl.

Who Can Make a Reasonable Profit at Today’s Oil Prices?

About 20 years ago, the price of a barrel of American oil was below $28/bbl. Ten years ago it was about $75/bbl. The value of US oil reserves has increased exponentially in the 21st century, leading one to rightfully ask why producers – be it major players like Exxon Mobile or smaller entities – wouldn’t cash in while the going is good. The answer is twofold. If the supply floods the market and causes a glut, prices will surely be pushed down and margins will assuredly be impacted; Second, the economics of oil production are complicated and not straightforward. Consequently, the economics of oil exploration and production are unlikely to be swayed by short-term political policy.

WoodMack’s Evan Clark explains that raising production is a tough sell to shareholders. “One of the things that oil companies are wrestling with is that there’s a bit of a bubbling up asking for people to produce more, but then there’s also some sort of rhetoric floating around about a goal of lower oil prices.” Further, he reminds us that companies are beholden to their shareholders, not the White House. After an era of extreme investment in new drilling techniques like fracking, the focus is now on returning value to shareholders and preserving resources for the longer term. “Shareholder returns and resource preservation aren’t priorities shareholders will forego out of allegiance to their country,” warned Rystad Energy’s senior analyst Matthew Bernstein.

So… What Can Trump Do?

Putting the jitters and swings of commodity markets, aside, the outlook for the industry, and output, depends really on one big factor -the duration of tariffs. Already, there are trade agreements resulting therefrom, and the eventual settlement with China is forthcoming I believe. Surely there will be one and soon. As to who it will appease, that remains to be seen but I can’t see anything but room for improvement from present-day events.

Although limited in scale, there are a number of tactics Trump can use to make drilling more economically attractive to shareholders. Changes to tax codes to offer reinvestment. Axing permitting red tape for smaller changes to wells already existing. But the one single move that Trump can take without Congressional approval would be to open more federal land for drilling. “There are some parts of federal acreage that is really competitive,” explained Clarke. “ So if the infrastructure was a bit better there instead of somewhere else? It can shift the cost curve a little to the point of where they drill as opposed to how much they drill.”

Critics claim this would effectively be encouraging “cannibalizing” from other areas of their portfolio. “In terms of industry implications,” explains Bernstein, “It would really be an offsetting effect where you would get some activity being brought there if operators care to do so, but it would come at the expense of other acreage.”

Trump can also nurture natural gas development, the red-headed step-sister of the business. It’s a little know fact that the US has more natural gas reserves than any country on the planet. Problem is, the price has been depressed seemingly forever. Many E&P companies choose to just flare off the gas from a well producing liquids, rather than go to the trouble of using separators or other equipment available to also produce the gas. And, while a mix of as much as 1/3 natural gas is desirable to help bring the liquids to the surface, it has often been considered nothing less than a nuisance. Not anymore.

I have been bullish on natural gas prices for a year now, encouraging friends and foes to make it a part of their investment portfolios. Why the sudden change? Two major reasons.

First, the growth and proliferation of LNG export facilities has become America’s natural gas savior. Especially during the Russian/Ukraine conflict, European countries were nervous about having to depend upon Russia for their natural gas needs. That pendulum has finally swung our way, and with Biden out of office and no longer able to place “moratoriums” on US LNG export facilities, it is surely to continue to grow exponentially. At present, at least eight facilities exist, mainly in Texas near the Gulf Coast, with `five more either permitted or under construction. This gas arrives, in vapor form, to the facilities who then cool it to incredible low temperatures, turning it into a liquid form and allowing a capacity thousands of times thereover to be shipped. The volume, capacity, and profit are all astronomical. Trump could actually be a pioneer here, instigating new opportunities for America’s natural gas producers, by fast-tracking permits and considering tax incentives to spur further development.

Secondly, AI has produced such a huge demand for power sources that natural gas seems to be the only logical solution at this time. Many AI facilities has sprung up in Texas, lured there by the seemingly unlimited production of the Permian Basin and the existence of the Barnett Shale, one unconventional reservoir that is almost entirely natural gas with regard to production. This demand is huge already and only going to increase in the near future. I see no logical component which can overtake natural gas in the near future in terms of being able to affordably provide for the incredible AI energy demand.

What Can Producers Do?

After several surprisingly profitable years under Biden, it may be time for the industry to “tighten their belts”. Efficiency in operations must be maximized. Basin locations must be factored in as they have already been explained to have different economics. Continued innovation and efficiency improvements in both drilling and completions must be applied to help lower production costs and improve profitability, even at lower oil prices.

Pray that this tariff “showdown” with China ends quickly. That is, far and away, the single biggest factor affecting prices. Since the first April 2 announcement, placing a 10% tariff on all imports, and promising more to be forthcoming DJT has proven he is totally focused on this issue. The inevitable world-wind of retaliatory tariffs began with China (most other countries of importance falling in line) of main concern. It’s a complicated used, one too complicated to analyze here. Something literally happens every day. I did see a very positive article on LinkedIn intimating that a reasonable agreement was eminent but I cannot vouch for that particular source. Regardless, we will all eventually adjust to the new normality that is the Trump Presidency. We have hit a few speed bumps before we reach the interstate.

“The sentiment in the industry…..is pretty much completely politically agnostic,” Bernstein explains. “The sentiment, in terms of what we’re expecting when budgets are renewed is varied– and based off of what was delivered at the end of last year. Basically, we’ll take the favorable rhetoric out of Washington, we certainly appreciate that there’s an unabashedly pro-oil and gas administration in the White House, but it’s really not going to affect their plans versus what it would have been a couple months ago,” he added.

Truth be told, it’s up to the shareholders of the producers that run the sector. Without the incentive for reasonable profits, they’re under no obligation to increase production. “We’re sticking with our corporate strategy,” reports Bernstein. That strategy focuses on three areas. First, the concern for shareholder returns. Second, to allow for and’ provide the means for moderate growth. And, third, a genuine and determined effort at capital discipline.

“We will be a rich nation again and it is that liquid gold under our feet that will help to do it,” as per President Donald J. Trump. Despite our many problems (too numerous to discuss) I remain optimistic and am determined to give President Trump a chance. He’s just been in office about 100 days. The near future will surely be interesting.