Management issues- Dallas Fed: Oil and gas expansion stalls amid surging costs and worsening outlooks

Growth in the oil and gas sector stalled out in first-quarter 2023, according to industry executives responding to the Dallas Fed Energy Survey. The business activity index—the survey’s broadest measure of conditions facing Eleventh District energy firms—was 2.1 in the first quarter, down sharply from 30.3 in fourth-quarter 2022, Fig 1. The near-zero reading indicates activity was largely unchanged from the prior quarter, a break from the more than two-year stretch of rising activity. 

Fig. 1. Measurement of oil and gas activity in Federal Reserve District 11.

OVERVIEW 

The Dallas Fed conducts the Dallas Fed Energy Survey quarterly, to obtain a timely assessment of energy activity among oil and gas firms located or headquartered in the Eleventh District (Texas, northern Louisiana, southern New Mexico). 

Methodology. Firms are asked whether business activity, employment, capital expenditures and other indicators increased, decreased or remained unchanged, compared with the prior quarter and with the same quarter a year ago. Survey responses are used to calculate an index for each indicator. Each index is calculated by subtracting the percentage of respondents reporting a decrease from the percentage reporting an increase.  

When the share of firms reporting an increase exceeds the share reporting a decrease, the index will be greater than zero, suggesting the indicator has increased over the previous quarter. If the share of firms reporting a decrease exceeds the share reporting an increase, the index will be below zero, suggesting the indicator has decreased over the previous quarter. 

Data were collected March 15–23, 2023, and 147 energy firms responded. Of the respondents, 95 were exploration and production firms, and 52 were oilfield services firms. 

Special questions  asked of executives this quarter include an annual update on break-even prices by basin; anticipated employee head count changes in 2023; the main factor influencing profitability; and the top cause of worker shortages in the oil field.    

OIL & GAS PRICES 

On average, respondents expect a West Texas Intermediate (WTI) oil price of $80/bbl by year-end 2023. Responses ranged from $50/bbl to $165/bbl, Table 1. Survey participants expect Henry Hub natural gas prices of $3.43 per million British thermal units (MMBtu) at year-end, Table 2. For reference, WTI spot prices averaged $68.51/bbl during the survey collection period, while Henry Hub spot prices averaged $2.23/MMBtu. 

COSTS/FACTORS 

Firms reported rising costs for a ninth consecutive quarter, as all series remained significantly above their averages. Among oilfield service firms, the input cost index was roughly unchanged at an elevated 61.6. Among E&P firms, the finding and development costs index slipped to 46.8 from 52.5. Additionally, the lease operating expenses index declined 11 points to 37.6.  

The supplier delivery time index for all firms moved into negative territory, declining to -14.0 in the first quarter from 14.4 in the fourth. This is the first negative reading since fourth-quarter 2020 and signals that it takes less time to receive materials and equipment, relative to the prior quarter. Among oilfield services firms, the measure of lag time in delivery of services declined to zero from 20.0, suggesting that delivery times for these firms are no longer increasing. 

One of the “special questions” asked of survey respondents was “In the top two areas in which your firm is active, what West Texas Intermediate (WTI) oil price does your firm need to cover operating expenses for existing wells? In response, the average price across the entire sample is approximately $37/bbl, up from $34/bbl last year, Fig 2. Across regions, the average price necessary to cover operating expenses ranges from $29 to $45/bbl. Almost all of the 83 respondents can cover operating expenses for existing wells at current prices. 

Fig. 2. Special Question on oil price required to cover operating expenses for existing wells.

A second special question asked of survey respondents was “In the top two areas in which your firm is active, what WTI oil price does your firm need to profitably drill a new well?” For the entire sample, firms need $62/bbl, on average, to profitably drill, higher than the $56/bbl price when this question was asked last year, Fig. 3. Across regions, average break-even prices to profitably drill range from $56/bbl to $66/bbl. Break-even prices in the Permian basin average $61/bbl, $9 higher than last year. Despite recent oil price declines, most of the 80 responding firms in the survey can profitably drill a new well at current prices. 

Fig. 3. Special Question on what oil price level is required to drill a well profitably.

Large firms (with crude oil production of 10,000 bpd or more, as of fourth-quarter 2022) require prices of $55/bbl to drill profitably, based on the average of company responses. That compares with $64 for small firms (fewer than 10,000 bpd).  

STRATEGY/FINANCIAL OUTLOOK 

The company outlook index turned negative in the first quarter, falling 27 points to -14.1. The overall outlook uncertainty index increased 23 points to 62.6, pointing to firms’ continued heightened uncertainty regarding their outlooks. Sixty-eight percent of firms reported greater uncertainty. 

Another special question posed to executives was “Which of the following do you believe will have the most influence on the profitability of your firm this year? The potential answers included cost inflation, health of the global economy, access to and cost of capital, government regulation, supply chain issues, and other, Fig. 4. Upon tabulation, cost inflation and health of the global economy were each selected by 30% of 136 executives as having the greatest influence on the profitability of their firm in 2023.  

Fig. 4. Special Question on which factor will have the most influence on a firm’s profitability this year.

OIL & GAS PRODUCTION 

Oil and natural gas production increased at a slower pace, compared with the prior quarter, according to executives at E&P firms. The oil production index remained positive but declined to 10.5 in the first quarter from 25.8 in the fourth. Similarly, the natural gas production index fell to 7.4 from 29.4. 

OFS SECTOR 

For oilfield services firms, the equipment utilization index slid 29 points to 3.9 in the first quarter. The operating margin index declined to 1.9 from 25.9. The index of prices received for services remained positive but declined to 25.0 from 43.6. 

EMPLOYMENT TRENDS 

Indexes related to employment and hours worked eased in the first quarter. The aggregate employment index posted a ninth consecutive positive reading but dipped to 14.3 from 25.7. The aggregate employee hours index declined to 12.3 from 27.7 in the prior quarter. Meanwhile, the aggregate wages and benefits index edged higher, to 43.6 from 40.2. 

Meanwhile, a special question asked of respondents was “How do you expect the number of employees at your company to change from December 2022 to December 2023?” More than half of the executives—55%—expect their head count to remain unchanged from December 2022 to December 2023, Fig. 5. Thirty-seven percent of executives expect the number of employees to increase, of which 4% expect a significant increase and 33% anticipate a slight increase. Only 8% foresee the number of employees decreasing over the period. 

Fig. 5. Special Question on how the number of employees at a company will change from December 2022 to December 2023.

Whereas the most-selected response among E&P firms was for employment to “remain the same” in 2023, the most-selected response of support service firms was for employment to “increase slightly” in 2023. (See table for more detail.) 

Fig. 6. Special Question on what is the primary factor causing worker shortages in the oil field.

A final special question asked executives, “Which of the following is the primary factor causing worker shortages in the oil field?” Forty percent of executives cited the cyclical nature of the industry as the primary factor causing oilfield worker shortages, Fig. 6. Another 27% selected “perception of limited career potential, due to the energy transition,” and 10% indicated “other.” Additional responses garnering less than 10%, each, include “lack of work-life balance and flexible work schedule,” “compensation in other industries,” “less-attractive work locations,” and “inability to pass drug test and/or background check.” 

Comments from Survey Respondents 

These comments are from respondents’ completed surveys and have been edited for publication.   

EXPLORATION AND PRODUCTION (E&P) FIRMS 

• Oil price correction is adding pressure on the continuation of drilling and frac activities. [We] expect the activity level to be flat-to-down in 2023 versus 2022’s exit. 
• The dramatic increase in 2022 inflation has severely, negatively impacted project economics. 
• Uncertainty of the depth and duration of a bank crisis is causing us to be nervous about capital spending plans in 2023. 
• Oil in recession trades like a financial product—supply/demand fundamentals matter less. Chickens seem to be coming home to roost; it turns out loaning out trillions of dollars with zero interest rates (or in the case of Europe, paying folks to borrow money) was not our finest hour. 
• Regulatory uncertainty continues to be a headwind. Inflation pressures appear to be moderating slightly, but we still have a long way to go. 
• Permitting delays [caused] by the administration’s policies have caused us not to drill two wells we had hoped to drill this year. The BLM (Bureau of Land Management) is holding them hostage. 
• The current low oil prices, coupled with the banking scare, will be hard on smaller, undercapitalized companies to conduct business as usual. There will be tougher credit and lower reserve values because of new price decks. 
• A growing concern in West Texas is that the reliable, generated supply of electricity is not growing, while consumption of power has grown roughly 50% over the past 24 months. This could lead to a future moderation of basin-wide activity if power supply cannot meet future demand. 
• Crude oil is about to join natural gas in contango, which is highlighting a nervous macroeconomic picture. There are plenty of buyers at this calender strip price and not a lot of sellers. Not seeing financial distress with all of the cash accrued since last year. The only way people are in trouble is if hedges are under water or if they blew out authorization for expenditures. 
• An estimated 30%-to-40% cost increase in field operations, increased interest charges on borrowed money, a drastic collapse in natural gas prices combined with lower crude oil prices produced a noticeable lower cash flow. Service company capacity is quite limited in select basins. Outside investors seem to be losing interest in hydrocarbons. The worldwide macroeconomic and political outlook is cloudy. The road ahead looks difficult but passable. We expect another "muddle through" period in a cyclical business, where more players will be winnowed out. 
• The uncertainty in oil and gas prices is making it difficult to plan for the future. Between government regulations and oil and gas prices, it is becoming more and more difficult to remain in the oil and gas business. 
• We expect oil and gas production to decline in 2023, due to higher drilling and completion costs. The significant factor is the lack of qualified employees. The second [factor] is the negative impact of environmental, social and governance initiatives. 
• Government roadblocks are our biggest and most insidious obstacles to overcome. Both the current administration and the governor of California are dreaming up new ways to add costs, delay permits and prevent drilling and leasing. 
• Financing unexpected capital calls has gotten more challenging with the Federal Reserve's interest rate increases and the government’s war on oil and gas. We're finding more creative ways to get financing. Current banking is starting to prove "difficult" due to "attitudes" from constantly shifting young bank officers, despite 27 years of business with the same bank. Silicon Valley Bank and associated banking meltdowns are impacting commodity prices. Our operators are reporting that they are having trouble getting materials, parts, pumps, pipe and tubing into West Texas projects. We are also noticing that most of our operators have reduced staffs and have replaced knowledgeable and experienced personnel with apparently cheaper "newbies." Oilfield inflation has to be the No. 1 problem. Capital expenditure increases are soaring well past consumer price index data. I'm noticing apparent quality problems beginning to plague new projects; specifically, I've never seen so many cases of parted tubing with new tubing, particularly with poor-quality collars, as I'm seeing in recent months. Is the U.S. importing more inferior-grade oil country tubular goods now? 
• Mixed messages sent by the current administration respecting the necessity for fossil fuel production, scarcity of labor, increased cost of materials and supplies, domestic and foreign political risk, demand volatility and economic uncertainty domestically have each contributed to an environment that is difficult to work and make plans in going forward. In addition to those factors, the increased cost of capital has negatively impacted the ability to participate in projects that could enable the organization to grow. 
• The rig count has fallen for the past two months. Shale producers have drilled most of their tier 1 quality. The Bakken is seeing itself reach a bubble point, and natural gas is increasing in new completions with less crude oil. Natural economics occurs in the patch. Values drop and so do activity and production levels. Supply and demand are priced accordingly. Global issues also can play a part. Climate change activists are causing disruption. 
• The biggest threat to our business is the federal government. The public narrative, directed by Washington, that the world is moving away from oil and gas is a very big problem. It directly affects our ability to raise capital. This must stop. It's easier to finance a vape shop or a tattoo shop than it is to finance oil and gas. There is something seriously wrong here. 
• Market risks, both directly and indirectly related and unrelated to oil and gas, have increased significantly and are likely to not be reduced by any action undertaken, suggested or omitted by the administration. 
• Frivolous environmental litigation from Bureau of Land Management leases and permits is obstructing our ability to properly develop our properties. Service cost inflation, combined with weaker commodity prices, will negatively impact future drilling plans, resulting in less activity. 
• The low oil and gas prices are impacting investment. Talk by government officials regarding the oil and gas industry makes one wonder why the industry should risk dollars. 
• Our industry has been affected negatively by the Russia–Ukraine war, and now there are concerns over the banking system. The continued mixed messages put out by the administration are also contributing to the uncertainty and unwillingness to put additional funds toward development and growth. 
• The administration’s policies will continue to affect domestic natural gas and oil production negatively. Oil and gas prices will soar in the next few years, and we'll be at the mercy of nations that hate us. 
• [There have been] no direct impacts to our company yet that we know of, but we are monitoring tremors in the banking system that surfaced over the past couple of weeks. 
• Volatility in commodity markets and recent banking turmoil continue to play into business dynamics and are leading to a reduction in spending plans. The dramatic pullback in natural gas prices has also led to a decrease in appetite to target gas prospects and has also led to some optional gas-rate curtailments. 
• Overall, prices have impacted the revenue but not yet costs. We are still waiting for costs to catch up with the new pricing levels. We do not expect prices to increase significantly. 
• It appears as if the war in Ukraine will continue. 

OIL AND GAS SUPPORT SERVICES FIRMS 

• The persistent labor shortage in the Permian basin shows no signs of easing. It is very difficult to fill mechanical and electrical positions with local residents. Our company is relying on shift workers from out-of-state to fill these spots, due to the shortage of local qualified workers. The growth of the electrical grid is not keeping up with demand. It will be increasingly difficult for the energy industry to meet stricter environmental regulations without significant investment in power generation and transmission. The infrastructure of the Permian basin continues to be maxed out. Roads are at capacity, and there are not enough local, state and federal dollars flowing into the area to properly construct and maintain safe roads. 
• We're at a crossroads, as activity levels are not matching service pricing. There seems to be a disparity at the operator level, where their reluctance to allow pricing increases doesn't match with their own internal financial success. What has long been a healthy operator-to-service-provider relationship is beginning to show signs of deterioration. 
• [We’re] still seeing inflationary pressures (wages and consumables) on a smaller scale. However, E&P companies are not as open to helping absorb the increases. 
• Labor remains the most significant challenge. Activity and revenues would be higher with additional employees. The lack of labor is also impacting vendors and turnaround times. The lack-of-labor issue includes both qualified mechanics/welders and general labor for oilfield services, who are able to meet employment criteria. 
• Regulatory uncertainty is a major overhang. Labor remains tight, with continued wage pressures. Supply-chain issues remain. 
• Finding workers is getting harder and harder. The potential pool of workers is probably not so different, but it is more a case of workers being able to collect more governmental assistance, so why work? 
• The likelihood of a recession has increased. Government at all levels is out of control. Regulation is killing the nation. Environmental issues are overblown to the point of the absurd. 
• We are seeing the vertical natural gas drillers drop rigs and defer projects, due to low natural gas prices and high costs, especially casing and tubing. Unlike the horizontal operators, these companies can stop and start very quickly. 
• Recent government actions related to backstopping uninsured losses, in the wake of the Silcon Valley Bank collapse, set a terrible precedent that greatly increases future policy uncertainty and, therefore, also increases future market volatility, as the market will always try to correct course, but with less and less time to respond. 
• Bank failures in March 2023 and concerns over the overall financial system have added to concerns over possible recession timing and severity, and the possible short-term impact on WTI [West Texas Intermediate]. Gas-directed activity, especially in the Haynesville [shale], is being negatively impacted by takeaway limitations and significant declines in Henry Hub natural gas prices since third-quarter 2022. Credit was already tight for oilfield services companies; I expect availability of credit will tighten even more, making business conditions tougher for companies without the necessary operating scale. 

About the Authors

Michael Plante

Dallas Federal Reserve Bank

Michael Plante joined the Federal Reserve Bank of Dallas in July 2010 and is senior research economist and advisor. Recent research has focused on such topics as the economic impact of the U.S. shale oil boom, structural changes in oil price differentials, and macroeconomic uncertainty. He also has been the project manager of the Dallas Fed Energy Survey since its inception in 2016. Mr. Plante received his PhD in economics from Indiana University in August 2009.

Kunal Patel

Dallas Federal Reserve Bank

Kunal Patel is a senior business economist at the Federal Reserve Bank of Dallas. He analyzes and investigates developments and topics in the oil and gas sector. Mr. Patel is also heavily involved with production of the Dallas Fed Energy Survey. Before joining the Dallas Fed in 2017, he worked in a variety of energy-related positions at Luminant, McKinsey and Co., and Bank of America Merrill Lynch. Mr. Patel received a BBA degree from the Business Honors Program at the University of Texas at Austin and an MBA degree in finance from the University of Texas at Dallas.