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:
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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