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Margins are Good in the Oil Patch Despite Investor Indifference

2022 is a pretty good time to be an oil and gas company. That statement might surprise casual energy market observers, who read constant headlines about renewable energy or ESG investing. While the people and governments of wealthy nations are focused on an energy transition, global demand for petroleum fuels continues to climb as more of the world’s people make strides toward higher income levels and consumption.  But anticipation of the energy transition (and overzealous assumptions on timing) is scaring off just enough investment in the sector to buoy prices at levels producers once dreamed of.  And these prices, combined with hard-won efficiencies gained over the last several years, are translating to some of the highest margins witnessed over the previous decade.

Today’s Energy Market Insight revisits a favorite topic, the economics of producing oil from US shale basins.  The economics of production involve not just the project economics of drilling new wells, but the corporate costs that go into running companies that drill those wells.  E&P companies have been under pressure to shrink both operating and non-operating expenses for years now.  The past two years of uncertainty whiplashed oil markets, but more recently higher prices brought in cash flow that was used to reduce outstanding debt for many companies.  So what has changed with some of those corporate costs, and what is the cost to produce today?

The chart below shows G&A expense on a per barrel of oil equivalent (BOE) for a group of publicly traded independent oil-focused producers for the most recent quarter as well as a comparable quarter two years ago (just prior to the impacts of the pandemic).  Approximately half the companies in sample reduced G&A expense on a per BOE basis over the past two years.  For the group, the median G&A expense fell from $2.50/BOE to $2.00/BOE, with the range from $0.69 – $5.97/BOE. 

Interest burden is another corporate expense that must be factored into the cost of doing business in the industry.  While in 2021 companies have taken strides to reduce outstanding debt, many of those same companies increased borrowings in 2020 when the fall in oil prices disrupted cash flow.  Interest expense per BOE produced increased for 56% of the companies in the sample over the two year period.   

While G&A and interest expense are not the only two non-operating expenses E&P companies have at the corporate level, they are the most consistent.  When we aggregate these expenses on top of a production weighted breakeven, we get a baseline for understanding the potential for returns in the industry.  This analysis suggests that most operators have the potential for profits at oil prices $50-60/bbl, and that margins are extremely healthy at $70-80/bbl.

Healthy margins in commodity markets aren’t usually sustainable.  But just as the previous decade was marked by persistent pressure toward oversupply, many factors are aligning to support a more constructive outlook for the oil and gas sector in the next few years.  For price forecasts and more detailed thoughts on the fundamental balance for oil markets, request a sample of BTU’s Oil Market Outlook.  And for more detailed information on well-level economics, operator trends and remaining inventory by breakeven price, request a trial of BTU’s Oil & Gas View.

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Kathryn Downey Miller is President of BTU Analytics where she leads the firm’s consulting and analytics groups in delivering market advisory services to clients across all sectors of the industry. Additionally, Kathryn oversees strategic planning, financial budgeting and analyst development for the company. Prior to founding BTU Analytics, Kathryn built market expertise in a diverse set of prior industry roles, including buyside investment research at an energy focused hedge fund, energy market fundamentals consulting at Bentek Energy, investor relations strategy consulting for E&P companies and investment banking at Citigroup. She speaks frequently at industry events on North American energy markets and is a CFA charterholder.

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