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E&P Costs Incompatible with Natural Gas Demand Growth

Written by Matthew Hagerty | Jan 20, 2023

As a result of the bumpy recovery from the Covid-19 pandemic, inflation has become a key source of risk in the oil & gas industry. While some U.S. producers were able to stave off the effects of rising costs in 2022, nearly every major operator has accounted for rising inflationary risks in 2023. The importance of this trend, as BTU Analytics detailed in its 100th Edition of our Upstream Outlook, is that even though U.S. natural gas demand is expected to rise rapidly in the latter half of the decade, the bulk of this demand will likely need to be met by associated gas coming from oil-driven plays. Therefore, this Energy Market Insight will look at the impacts that some levels of cost inflation could have on natural gas production going forward and whether associated gas from oil-driven plays will be able to balance U.S. natural gas markets.

For those in the U.S. upstream space, inflation is largely the result of tight labor markets, shortages of materials, such as steel and frac sand, and the continued desire of oilfield servicers to improve margins after several years of low equipment utilization and poor returns. All of these factors contribute to the total cost to drill and complete a well, which ranged from $7–9 million in 2022 for an average Permian well. If inflation were to increase drilling and completion costs by 10–20% this year, as a majority of public producers have guided for, then the completed well costs for the average Permian well could be as high as $8.5–11 million.

In the elevated price environment of 2022, where both Henry Hub and WTI traded comfortably above average breakeven prices, a 10–20% rise in costs might not affect a producer’s decision to bring another well online. However, as BTU Analytics expects Henry Hub pricing to fall below $3/MMBtu this summer, activity in gas-directed plays, such as the Haynesville, are likely to slow. Furthermore, as public producers continue to focus on cash flow and controlling CapEx spending, they are likely to be less willing to absorb multiple years of high-cost inflation while leaving activity unchanged.

As shown above, should drilling and completion (D&C) costs remain at or near the elevated levels E&Ps are currently guiding for, then U.S. oil-driven plays will do little to balance U.S. natural gas demand markets under BTU Analytics’ current oil and gas price forecasts. Also, as most of the gas-directed regions are unable to grow production due to infrastructure and inventory constraints, even a small deviation in production in oil-driven plays would have major implications on the ability for the U.S. to meet the natural gas demand that is expected to come online in 2026 and beyond, when incremental LNG capacity is expected to begin ramping up.

BTU Analytics predicts that a higher inflationary environment in 2023 will most likely lead to one of three outcomes. Either these higher D&C costs will self-correct by forcing activity and production to slow, producers will be forced to re-evaluate the continued commitment to shareholder returns at the expense of production growth, or pricing will need to rise above BTU Analytics’ forecast in 2026 and beyond to encourage greater investment in production.

Be on the lookout for info on our upcoming webinar on March 1, which will discuss this topic in even more detail! Also, click here for more info on all of our oil and gas offerings, which dive into production, pricing, infrastructure, and supply and demand dynamics.

 

 

BTU Analytics is a FactSet Company. This article was originally published on the BTU Analytics website.

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