(Editor’s Note: This story is one in a series providing expert forecasts for the global natural gas and oil markets in 2022. Look for NGI’s extensive coverage of what happened in 2021 and what can be expected in 2022 and beyond in terms of prices, the LNG export markets, ESG, Mexico’s production and project prospects, North American midstream infrastructure plans and exploration and production strategies.)

Natural gas and oil producers in the United States are likely to increase their overall capital spending this year as they face a supply chain squeeze, labor issues and higher prices for services, but the mantra to remain disciplined has not changed.

NGI discussed the year ahead with analysts who cover the oilfield services (OFS) and the exploration and production (E&P) sectors. Insights from various forecasts also were compiled to get a read on expectations for the year. 

This year has begun with a bit of uncertainty as Omicron joined the cast of coronavirus infections sweeping around the globe. While a bit volatile, oil and natural gas prices were holding somewhat steady by mid-January. 

Rock & Roll & Reset

Evercore ISI’s analyst team had been optimistic as last year began, offering the “Three R’s” for the industry: resilience, reflation and reacceleration.” For this year, analysts have added “reset” as the dominant theme.

“Now looking into 2022, we remain bullish as we believe we are in the early stages of a long and strong multi-year E&P spending upcycle,” Evercore’s E&P and OFS teams led by Stephen Richardson and James West. 

“We believe the industry will experience a globally coordinated spending upturn for the first time since 2018, with activity growth broadening across the world.”

In North America, the “new normal” is likely to be the theme, with a “structurally smaller U.S. land market” and the private E&Ps controlling more of the activity, as they did in 2021. 

“Privates will continue to increase activity, further tightening land drilling and pressure pumping markets.”

The U.S. land rig count is expected to exceed 600 by the end of March or early in the second quarter, according to Evercore. The domestic rig count in the onshore was at 570 for the week ended Jan. 7, according to Baker Hughes Co. 

The domestic pressure pumping sector averaged 230-250 active fracture spreads for most of the second half of 2021, but Evercore’s team is predicting a rise to 275 spreads.

Meanwhile, a tight supply chain and rising prices for almost everything became apparent during conference calls during the third quarter. Those issues are “unlikely to abate” until the second half of this year.

“The amount of times ‘inflationary measures’ were mentioned hit an all-time high as of 3Q2021 earnings season, with a 6.6x increase compared to 3Q2020 and a 43% sequential increase,” the Evercore analysts said. “We’ve observed nearly every company in our coverage universe implementing pricing increases in order to pass through rising raw material and logistics costs to customers, although inflationary headwinds will continue to dominate the narrative next year.”

‘Historically Low’ DUCs

How much activity rises this year in the United States remains a question. Activity continues to increase, but in modest increments, according to Mizuho Securities USA LLC.
“We estimate that 13 rigs weekly would need to be added across the Big 5 plays over the next eight weeks in order to reach a sustainable level of drilling activity to maintain current U.S. oil production volumes,” Mizuho analysts said during the second week of the new year.

“Completion cadence across the Big 5 is likely sufficient for growth,” but the drilled but uncompleted (DUC) inventory is now “at historically low levels.” More drilling activity is needed or it “could put a ceiling on U.S. supply in 2022.”

To deliver sustainable oil volumes through next year based on current levels, “we believe the rig count across the Big 5 U.S. oil plays would need to increase by 100 rigs, versus an 178 increase in rigs since the start of 2021,” the Mizuho team said. 

“To deliver on our forecast 600,000 b/d call on year/year U.S. unconventional oil growth to balance global markets, we believe 121 additional rigs are necessary.” The DUC inventory “is no longer sufficient to support current completion cadence, as inventory relative to overall production is already less than half average 2018-2019 levels.”

During the Goldman Sachs Global Energy and Clean Technology Conference in early January, EOG Resources Inc.’s CEO Ezra Yacob said the Lower 48 producing giant was monitoring global oil demand and inventories to determine when to invest more capital. That time could come by this summer, if the market “clearly needs the barrels,” Yacob said. 

However, if the call on unconventional oil growth emerges for EOG and others, “industry will be slow to respond, given tight supply chains and labor markets,” according to the Mizuho team. “Anecdotally, we have heard that costs for a new well at current labor and materials costs is likely another 10-20% higher – on top of the 10-15% year/year inflation spoken to on 3Q2021 calls.

“We believe that a bottleneck on energy supply is becoming more visible, with resulting higher commodity prices supporting the sector relative to the broader market.”

Shareholder Returns Still Dominating?

Once the E&P budgets are finalized and announced in the coming weeks, Tudor, Pickering, Holt & Co. (TPH) said returning capital to shareholders may “dominate conversations, something we see as a likely occurrence through the February timeframe.”

The energy sector “had a great run in 2021,” and “we continue to see further gains on the horizon in 2022, underpinned by our constructive outlook on crude oil.” 

The firm is forecasting first half oil prices to average $80-85/bbl as global demand recovers.

Other analysts, including Goldman Sachs Group, said oil prices could reach triple digits this year. Goldman has pegged average oil prices in 2022 to be around $85/bbl.

“Clearly this Omicron still presents uncertainty,” said Samco Capital Markets Inc.’s Jacob Thompson, a managing director. Supply trailed demand to begin the year, and he emphasized that inflation has permeated nearly every sector, including the OFS sector, which could put further upward pressure on prices.

Not only have E&Ps kept their word about living within cash flow, they have “surpassed all expectations,” according to analyst John Freeman of Raymond James & Associates Inc.

“Reinvestment rates, currently at historic lows, have led to record profitability. E&P free cash flow yields, something unknown to the sector just five years ago, are now the highest in the market. 

“Even shareholder returns, previously thought to be extinct in the E&P sector, are commonplace among nearly every company within our coverage (via buybacks and dividends).”

Last year was a “renaissance of sorts” for the E&P sector, Freeman said. Producers were beaten down by the pandemic in 2020, “with many fighting for survival.” Last year, though, the E&P stocks covered by Raymond James climbed by 117%. For perspective, the covered producers outperformed the S&P 500 “4.5 times over,” Freeman noted. 

“And yes, while oil’s meteoric rise (up 73% year/year) can be attributed to the lion’s share of positive momentum, not all operators fared equally.” Still, even with the run, E&P valuations trail pre-pandemic levels, he said. 

What’s The Forecast For Natural Gas Prices?

The Raymond James analyst team said U.S. natural gas prices averaging around $4/MMBtu “still seem possible” this year. Gas, which provides about one-quarter of the world’s energy today “typically takes the backseat to crude oil,” he said.

However, investors, market observers and consumers “may be looking at the natural gas market differently this year” following the dramatic rise in gas and electricity prices in 2021, particularly in Europe.

“We now think it will take a Henry Hub price of $4.00 to balance the U.S. market in 2022, versus our earlier forecast of $4.50,” Freeman said. Public E&Ps remain focused on their oil-heavy acreage, which has kept a lid on domestic gas supply growth. 

Most of the analyst team’s modeled gas supply growth is from the Permian Basin and Haynesville Shale.

“In fact, the once dominant Marcellus/Utica, which accounted for nearly half of all U.S. gas growth from 2018-2019, will see virtually no growth in 2022,” according to Raymond James.

For the public E&Ps in North America, the mantra remains capital discipline, with many indicating they will keep output at maintenance levels this year. 

“E&Ps are not chasing production growth anymore,” according to Raymond James. “We know we sound like a broken record, but the public E&P mindset has dramatically changed, and even in the face of higher prices, we have seen minimal deviation from maintenance-type programs.

“In fact, we estimate that the average E&P in our coverage universe spent 1% less than the original 2021 budget despite significantly higher commodity prices.”

The same cannot be said for their private counterparts.

“Although private operators account for a materially smaller amount of total U.S. supply than years prior, the private E&P rig count has now surpassed pre-Covid levels, nearly doubling that of public E&Ps.” 

2022 Resolutions

Out with the old, in with the new is an oft-said phrase around the new year, but the U.S. E&P industry overall should remain disciplined, analysts said.

The sector entered this year “in fine health but with some firm resolutions for the new year,” said senior fellow Ben Cahill of the Energy Security and Climate Change Program at the Center for Strategic and International Studies.

“As usual, the challenge will be sticking to those goals.The industry remained disciplined on spending last year after sharply cutting capital in 2020. The end result has been “enormous free cash flow” for the Lower 48 producers, Cahill said. 

“Now the question is how the industry can raise spending from unsustainably low levels over the past 18 months while keeping its focus on profitability.”

Shareholders have been rewarded with dividends, but less capital expenditures (capex) have been directed to exploration and development. IHS Markit’s Daniel Yergin, vice chairman, told NGI recently that push has come to shove, and E&Ps have to step up their investments to hold the line on sustaining and growing oil and gas reserves.

Cahill agrees. 

Capex now is at an overall “unsustainable level of investment,” Cahill said. “Last year most shale companies reinvested less than 50% of their cash flow in new drilling, as the industry downshifted into ‘maintenance capex’ mode.”

As initial production rates for wells are inclined to slide quickly, E&Ps have to keep drilling to sustain and expand volumes.

“They can only pull back on investment for so long without sacrificing future production levels and cash generation,” Cahill said. “Companies want to extend the policies that created bumper profits last year, and shale players are wary of an investor backlash if they ramp up spending too quickly. 

“But the concept of capital discipline is evolving. It is safer – and perhaps even necessary – for companies to grow again, albeit at a slower rate.”

Evercore surveyed global E&Ps in late 2021 to gauge what level of capital expenditures (capex) may be in sight for 2022. Worldwide capex is pegged to rise by around 16% year/year, extending the 5.5% growth from 2020. It would be the “first coordinated global upsturn since 2018,” the analyst team said.

North American E&P capex is seen leading the way this year, up by 23.5% from 2021, led by the privates, which are seen boosting their spend by 42%. The public independents are likely to raise their spending too, by about 26.5% in 2022. International spend is forecast to climb by 15% from 2021 and could surpass its 2014 peak by 2025, according to Evercore.

“Generally positive trends in commodity prices may have stalled due to the latest Covid strain, but we expect Omicron to have a limited impact on mobility and global demand,” according to Evercore.

Likewise, Rystad Energy’s team earlier in January predicted that global oil and gas capex may increase by 4% year/year to $628 billion.

[Want today’s Henry Hub, Houston Ship Channel and Chicago Citygate prices? Check out NGI’s daily natural gas price snapshot now.]

“The pervasive spread of the Omicron variant will inevitably lead to restrictions on movement in the 1Q2022, capping energy demand and recovery in the major crude-consuming sectors of road transport and aviation,” said Rystad’s Audun Martinsen, head of energy service research.

However, even with the pandemic-related disruptions, “the outlook for the global oil and gas market is promising.”

Rystad expects natural gas and LNG capex overall to climb the most this year, up 14% from 2021 at $149 billion. Upstream oil investments are forecast to increase 7% to $307 billion. Meanwhile, midstream and downstream spending is pegged to decline by 6.7% to $172 billion.

OFS Costs Climbing

Higher OFS costs are going to trickle down and likely impact their E&P customers this year.  Evercore’s recent survey results indicated that the “services market is beginning to tighten. 

“Operators are beginning to increase exploration budgets and expect service pricing to broadly increase, led by labor, tubulars and transportation but also fracturing/stimulation, drilling and other services.”

E&Ps generally are hesitant to adopt expensive technologies, but “they are increasingly willing to switch and pay up for services or technologies that lower carbon emissions,” said Evercore’s James West.

“Around this time last year we dropped our bearish view and turned bullish, as we believed the worst was behind the industry, the OFS companies re-invented themselves, and the recovery was poised to begin.

“Now looking into 2022, we remain bullish, as we believe we are in the early stages of a long and strong multi-year E&P spending upcycle.”

OFS operators are likely to become even better allies to the E&P sector as key players in the transition to net-zero carbon, according to Evercore. The OFS sector is helping customers reduce emissions during well construction and production, and providing technology to decrease the carbon footprint. OFS players also are investing in emerging energy resources, including geothermal, hydrogen, lithium and other materials. 

“This emerging world needs technology, infrastructure and most importantly, scale,” West said. “As the OFS industry provided this for the oil and gas industry for the last 150-plus years, so will the OFS and transition technology companies provide for the brave new world which is emerging.”