Onshore U.S. drilling activity cratered in summer 2020 as the number of active horizontal rigs dropped 70% from pre-pandemic levels to ~200 rigs. Given Saudi Arabia’s unexpected cut earlier this year of 1 Mbbl/d of oil and pent-up economic activity signaling increased liquids demand for 2H21 and 2022, we are cautiously optimistic that prices can sustain low-to-mid-$50s/bbl WTI over this period. As a rise in oil prices can signal a return to business-as-usual, with a resurgence in oil production, our clients often ask whether there’s potential for low-cost associated gas, a byproduct of many oil wells, to flood the market and how likely we are to return to the days of $2.50/MMBtu gas.
COVID-19 undoubtedly crippled the U.S. supply machine, but a more persistent, albeit less abrasive, force remains in motion. Investor demand pushing towards increased environmental sustainability and a focus on free cash flow generation – sometimes called shale 3.0 – suggest the landscape for future growth coming out of oil-leveraged plays looks very different in the next five years relative to the past five. We believe U.S. oil production will decline through 2021, signaling a nearly 1 Bcf/d decline in associated gas production. While we expect growth to return in 2022, we think there is downside risk as the oil price outlook remains a delicate balance against the backdrop of competing global factors.
At the play level, we expect Permian and Eagle Ford operators to exercise capital discipline and reinvest within 70% of free cash flow, enabling them to keep a measured pace of growth. While a similar story holds in the Rockies region, the prevailing thesis is underpinned by dwindling core inventory, a challenging political climate and bankruptcies combining to lower activity levels. Lastly, in the SCOOP | STACK, we believe marginal economics suggests a sustained commodity price recovery in the mid- to high-$50s range for 2022 and beyond is required before a material return of capital allocation from those multi-basin operators that were historically the most active in the play.
FIGURE 1 | Associated Gas Production (2021-2022)