Apache’s drastic rig cuts hit brakes on shale

2/12/2015

BRADLEY OLSON

HOUSTON (Bloomberg) -- Apache Corp.’s decision to sharply curb the growth of its oil output this year suggests that the major U.S. shale producers who helped create a global oil glut will be able to reduce supplies faster than expected.

One of the biggest operators in Texas’s prolific Permian basin, Apache will cut the number of rigs it uses to drill for oil by 70% by the end of the month, the company said Thursday in a statement. That’s going to slow output enough to keep production flat for the year, compared with the Houston-based company’s November forecast for growth of as much as 12%.

Unlike huge, billion-dollar oil developments elsewhere, U.S. shale producers surprised the world with their speed in ramping up production. That nimbleness means they’ll also be able to slow down quickly, said Tyler Priest, a historian at the University of Iowa who has researched past oil busts.

“In the past, there has been less of an incentive to reduce production because companies had already spent huge sums to ramp up, such as offshore or other areas,” he said in a telephone interview. “Now with shale, you’re constantly having to rig up and drill new wells. The industry as a whole can respond more quickly to downturns and volatility.”

The question that’s been looming over oil markets is how fast shale producers will hit the brakes. Apache’s plan to keep output flat shows that efforts to reduce oversupplies might produce results more quickly than the market has anticipated.

2015 Outlooks

“The time delay between a price drop, a board meeting, a rig release and an empty barrel is relatively short—measured in a few months,” Peter Tertzakian, chief energy economist for ARC Financial Corp., said in a Feb. 10 note to investors.

Apache was the first big shale producer to provide a production outlook for 2015 as it reported a $4.81 billion fourth-quarter loss Thursday, including writedowns on drilling asset values.

More U.S. shale companies will be reporting plans with the release of their earnings over the coming week.

Apache’s production cuts underscore how completely oil markets have changed amid an unexpected U.S. energy renaissance. Now, instead of Saudi Arabia and its OPEC allies controlling world prices, the pressure is on U.S. drillers such as Apache to rebalance the market.

“We believe it more prudent to curtail our activity until costs are lower and prices recover,” Apache CEO John Christmann, who took over last month, said Thursday in a statement.

Small Universe

The company is one of 19 producers that account for more than half of all U.S. production outside of Alaska. A universe of 91 companies is responsible for 81% of the output in that region, according to ITG Investment Research. That data suggests that a small group of companies have a lot more influence on global prices than they’ve had in many years, said Edward Hirs, managing director of Hillhouse Resources LLC.

“It’s much better not to produce right now while oil is so cheap,” said Hirs, who teaches courses on energy economics at the University of Houston. “You know it’s in the ground, so you wait until the recovery.”

Oil companies from Exxon Mobil Corp. to Royal Dutch Shell Plc have promised spending cuts exceeding $43 billion. On Thursday, Total SA announced a net loss of $5.66 billion, its first since 2008, and said expenditures would be reduced by up to $3 billion.

Growing Anyway?

So far, many industry forecasters are still seeing overall U.S. production rising this year despite an almost 30% drop in working oil rigs. In part, that’s because companies are focusing on so-called sweet spots and improved techniques that allow them to produce more oil at less cost. U.S. oil rose 4.9% to close at $51.21/bbl, less than half the price in June.

Crude output in the top three U.S. shale plays is expected to continue growing in the first quarter of the year as reductions so far haven’t been enough to curtail the expected supply needed to boost prices, Goldman Sachs Group Inc. said Feb. 10. Citigroup Inc. said oil could drop to “the $20 range” by April as oversupplies build.

A steady drumbeat of oil company cutbacks is beginning to alter that picture. The reduction in drilling rigs and a “huge seasonal pickup in oil demand” in the third quarter are likely to bring prices up “quicker than many expect” later this year, analysts from Haywood Securities Inc. said Thursday in a note to investors.

‘Transitional Year’

Investors on Thursday initially rewarded Apache for holding output steady. Shares rose more than 4% in intraday trading to as high as $67.57 before falling slightly at the close after the company announced it wouldn’t divest assets in Egypt and the North Sea. In past years, shale companies have risen or fallen largely based on growth. If investors reward drastic cuts and output reductions instead, it could prompt more companies to follow suit.

Apache wrote down the value of its oil and gas assets by $2 billion. Profit adjusted for those writedowns and other one-time items was $404 million, or $1.07 a share, 31 cents higher than the average estimate of 30 analysts compiled by Bloomberg.

“It was a strong end to a transitional year,” Brian Youngberg, an analyst at Edward Jones in St. Louis, said Thursday in an email. “We expect the company will be more proactive and better managed going forward.”

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