In a previous AlphaSense blog post, I wrote that U.S. oil executives were preparing to grow their organizations again.
Since then, a half-dozen private hydraulic fracturing companies have declared intentions to go public, drilling budgets have exceeded expectations, and the rig count has increased. 
Rapid growth does not happen in a pricing vacuum, particularly given the deflation that has wreaked havoc on oilfield service company margins over the past few years. So, as the oilfield supply chain now tightens in response to growth, inflation worries have returned.
The definition of “risk” in the oil business can change on a dime. Today, fears have quickly transitioned from, “is this a 1980s crash repeat?” to, “will supply chain inflation slow the recovery?”
In the 1980s, the oil and gas (O&G) industry underwent a catastrophic downturn that extended into a long period of depressed and stagnant conditions. 
To highlight this shift in thinking, I delved into the vast library of company documents available in AlphaSense. Here are two company statements addressing risk, showing how the meaning has changed from November 2015 to February 2017.
|November 5, 2015
Finally, I’d just like to sum up by saying this has been a very challenging year, and we know it’s not over yet. We’re basically caught up in a global price war. And I can assure you from past experience that this is just as vicious of a cycle as we experienced back in the 1980s. This price war has tested us, and it looks like it’s going to continue to test us through 2016 and 2017, maybe longer, we don’t know. But I think what we’ve demonstrated with our results that we have held our own, and we believe we’re making the company into a much better company.
– Mel Riggs, President & Director, Clayton Williams Energy, Inc.
|February 23, 2017
I can tell you we continually reassess [inflation] as we are seeing the $55 world that we are living in today on a three-year strip is really encouraging a lot of rigs to come back to work. Service companies are coming back to work as well. So, ultimately, the answer to the inflation question, which I believe is probably one of the most significant risks to anyone’s plan, you really have to understand how the service companies are responding to the rig growth and how the rig growth is responding to the commodity price, whatever that shakes out to be.
– Clay Gaspar, SVP & COO, WPX Energy, Inc.
Inflation could become a serious issue for exploration and production companies (E&Ps) later this year. That’s because E&Ps are relying on deflated input pricing to make their oil production profitable at $55 per barrel. The U.S. oil industry is growing again without the support of a full commodity price recovery to prior levels, making cost savings critical.
Today, one of the biggest debates in the oil industry centers around the sustainability of the cost reductions E&Ps achieved during the downturn. Oil well cost efficiencies have been key to the U.S. activity rebound – with oil at $50 per barrel. E&Ps have routinely touted capital cost reductions of anywhere from 20% – 50% per well from peak to trough in key, tight oil basins.
If these cost savings evaporate when suppliers raise prices in response to higher demand, then the nascent recovery in the oilfield could grind to a halt.
Using keyword search in AlphaSense, I set the Sources filter to Event Transcripts and the Industries filter to Integrated Oil & Gas and Oil & Gas Exploration & Production, and was able to quickly tally up how many E&P management teams talked about inflation during the last four year-end earnings seasons.
Management teams typically address the outlook for the new year during year-end calls. So, any big market risks that are top-of-mind typically surface in the Q&A, if not the prepared remarks.
Based upon my research, the E&P universe wasn’t worried about inflation a year ago. But starting in Q4 2016, they’ve been talking about inflation more than at any point in the past 4 years (even going back to when oil was priced up at $100 per barrel). A noticeable increase can be seen in inflation mentions on transcripts in the search trend chart within AlphaSense, displayed in the screen shot above.
AlphaSense captured the transcripts of CEO presentations at the Oil and Gas Investor conference held in February 2017, where inflation was a recurring theme. This commentary gives us a window into how some of the oil industry’s biggest producers are thinking about inflation risk right now. Here are three critical excerpts:
- Callon Petroleum Expects Suppliers to Return the Favor. “We’ve spent a lot of time last several years building relationships with several service providers, including Cactus, ProPetro, and I think we’ve supported them through the downturn, they supported us, and I think coming out of this, I think we’ll continue. Not that we won’t see some cost increases, but I think we’ll fair certainly as well, if not better, than some of the others. We had some recent increases in sand. I think it’s maybe 10%, 15% of sand, total well cost, but sand [costs increased] in the fourth quarter, and we built that in. And now that we’ve kind of built in 10% increase in well cost for this year, I think 15% through 2018, and we think certainly in pressure pumping we’re expecting to see increases there. On the drilling rig side, we’ve got three rigs with Cactus right now under contract, so we don’t see a lot there. And so I think we still are comfortable that 10% total well cost [increase], now, that’s going to come in different areas, some areas I don’t think we’ll see a lot. But I think 10% for 2017, so far.” – Fred Callon, CEO
- Whiting Petroleum Attributes Higher Cost per Well to Design not Inflation. “On a 14 million pound completion, for instance on that 10,000-foot lateral, that cost goes up to about $7.6 million from $6.8 million which is at 7 million pounds. Okay? That sort of frames the — and, again, we’re not modeling cost inflation in there because we see enough offsets right now. And, certainly, as we go above $55 oil, then you will start to see that cost inflation, no doubt about it. But, at this point in time, we’re not modeling that into those numbers.” – Pete Hagist, SVP Planning
- Pioneer Natural Resources Relying on Vertical Integration to Mitigate Service Inflation. “Pioneer is one of the most vertically integrated of all of our peers and so there was this talk in the industry of a 10% to 15% inflation move. We’re looking at probably net to us about 5%, but I think at a minimum we would expect that in terms of improvements of efficiencies and also productivity gains, so I think our net inflation number will be essentially zero when all the smoke clears for this year.” – Tim Dove, CEO
Consensus has formed among Wall Street analysts that U.S. onshore well costs will rise 10% – 15% on average this year (more in 2018). Given what we are hearing from industry contacts, expectations are too low. By the second half of 2017, inflation could begin to weigh on the industry’s recovery trajectory.
Joseph Triepke is the founder of InfillThinking.com, an independent research firm delivering oilfield market intelligence to subscribers. Prior to launching Infill Thinking, Joseph was an equity research analyst covering the energy industry for large buyside and sell-side institutions.
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