Independent upstream production companies focused on producing from shale formations or oil sands in North America were more profitable in the first six months of 2014 than in the prior two full years.
Cash return on equity (ROE), a measure of the profit a company earns on money shareholders have invested, increased 7 percentage points from 33% in 2012 to 40% through second quarter 2014.
In contrast, the cash ROE for global diversified vertically integrated oil and gas companies has declined slightly from 27% in 2012 to 25% through second quarter 2014 (Figure 1).
The analysis looked at 60 publicly traded companies that are required to submit quarterly and annual financial reports to the U.S. Securities and Exchange Commission, including both shale-focused producers in North America and globally diversified vertically integrated oil and gas companies. The groups differ in a number of areas. The producing assets of the global integrated companies are located in various regions of the world, while 98% of the assets of the shale-focused companies are in the United States and Canada. The former also tend to have multiple business segments, including exploration, production, midstream, refining, marketing, and chemicals; while the latter are almost exclusively exploration and production companies. The global integrated companies are generally much larger both in terms of liquids production and market capitalization.
In the first half of 2014, the group of global vertically integrated companies produced a combined total of 27.7 million barrels per day (bbl/d) of liquids and had total market capitalization of $2.9 trillion, while the shale-focused companies produced 1.6 million bbl/d of liquids and had a combined market capitalization of $240 billion.
The relative profitability of smaller shale-focused companies increased for a number of reasons. The prices paid to producers for crude oils produced in various shale formations have risen relative to North Sea Brent prices since 2012, increasing the relative revenue of shale-focused companies. While some of the spreads have widened recently, the overall trend since 2012 through second quarter 2014 has been narrowing spreads as rail and new pipeline infrastructure allow these crudes to reach more economically refining centers in the United States. Absolute U.S. prices for West Texas Intermediate (WTI) Cushing, WTI Midland, and Bakken have increased 7%, 4%, and 9%, respectively, in the first half of 2014 compared to their 2012 average prices. This has also contributed to higher domestic upstream profitability.
While increased prices have provided higher revenue, technological progress has improved productivity in various plays. Technological progress can increase overall production volume while reducing the cost per barrel of oil produced. According to EIA’s latest Drilling Productivity Report, new-well oil production per rig increased in the Bakken, Eagle Ford, Niobrara, and Permian regions from 2012 to 2014 (Figure 2).
Technology such as pad drilling can lower costs and decrease the time needed to drill a new well. This has not only increased production for the shale-focused companies, but has contributed to a reduction in operating expenses as a share of revenue from 30% in 2012 to 18% through second quarter 2014, according to the company financial statements. The volume of crude oil produced from various shale formations, in particular the Bakken, the Eagle Ford, and the Permian, has increased dramatically. For the shale group of companies as a whole, total liquids production has increased 430,000 bbl/d.
On a barrels of oil equivalent basis, almost all of the increases in production since 2012 have come from liquids, with liquids as a share of total oil and gas production increasing from 57% in 2012 to 63% through second quarter 2014. Most shale oil and gas companies have redirected their drilling to “wetter” plays–areas that yield higher levels of crude oil and hydrocarbon gas liquids relative to lower-priced natural gas.
The group of global vertically integrated companies has faced different conditions that have resulted in slightly lower returns since 2012. The average price of North Sea Brent crude oil, the global crude oil benchmark, was 2% lower through second quarter 2014 compared to the average 2012 price, which reduced profits from upstream businesses. Since this group of companies has more geographically diversified assets, some are exposed to geopolitical risks and were affected by unplanned crude oil supply disruptions. In addition, while some companies within the group did have increased liquids production from North American assets, similar to the shale-focused companies, production declines in other parts of the world decreased total liquids production volumes by 414,000 bbl/d compared with 2012. Other less-profitable business segments, in particular downstream refining operations in Europe, Asia and Latin America, also reduced returns for some companies.
In previous years, the returns of many of the shale-focused companies were affected by the relatively lower prices for North American midcontinent crudes as compared with global seaborne crudes. As crude oil distribution infrastructure has expanded, the price differences between Brent and U.S. and Canadian midcontinent crudes have narrowed, and relative returns for shale-focused companies have improved. EIA’s latest Short-Term Energy Outlook (STEO) forecasts the Brent-WTI spread to be $8/bbl in 2015, down from nearly $18/bbl in 2012, which, combined with improved productivity and lower costs, could make shale-focused companies less susceptible to absolute price declines.
Increased profitability is a contributing factor to STEO’s latest U.S. crude oil production forecast of 9.53 million bbl/d in 2015, 0.25 million bbl/d higher than in the August STEO and 0.18 million bbl/d higher than the forecast average for 2014.