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Cracks in the US shale recovery?

Oil bulls shouldn't get too excited about those capex cuts yet

Halliburton's chairman Dave Lesar set oil markets on edge this week with remarks suggesting that the shale industry was "tapping the brakes" as crude prices persistently hover around $50 per barrel ($/b).

To oil bulls and Opec ministers looking for cracks in the shale recovery, it was the first good news to come out of the tight oil patch in a long time.

Subsequent announcements this week—from major shale operators Anadarko, Hess and Whiting Petroleumthat they are cutting their 2017 budgets provided more grist for the mill. Anadarko cut $300m from its budget (roughly 7%) while Hess trimmed $100m from its spending plans. Further news of budget cuts could come over the next couple of weeks as companies announce their Q2 results and lay out their plans for the rest of the year.

Add the spending cuts to recent data points showing a slowdown in the rapid rate of growth in the rig count and Opec ministers might be tempted to start thinking they've finally slowed the shale colossus.

But it's too soon for celebrations.

Hess may be cutting its spending, but that doesn't mean output is suffering. Thanks to continued improvements in productivity and technology, the company said shale production in the Bakken is expected to come in at the very top end of its estimates for the year, at around 105,000 barrels of oil equivalent. Last year it said it needed six rigs to grow output at 10% a year. Now it says it can do it for the foreseeable future with just the four rigs already deployed. If US oil prices ticks higher, to $60/b or so, Hess could deploy another two rigs to add to the growth.

Anadarko cited the lower price in its decision to cut spending, but its troubles are also down to an especially heavy loss following an explosion at one of its Colorado gas production sites that forced it to shut in 3,000 wells.

The more relevant takeaway for the market was that the company's core shale business in Colorado's DJ Basin and the Delaware section of the Permian are still humming along. Anadarko says that productivity improvements mean it can deliver the same 15% annual growth it envisioned a year ago on $55 oil, at closer to $45/b now.

While the company's boss Al Walker has talked a lot about the necessity for the shale industry to rein in its drilling activities, his company isn't pulling back just yet. It says it will have 50% more completions in the DJ Basin in the second half of the year, which means more barrels hitting the market. The company also ramped up drilling in the Delaware and has amassed a large backlog of drilled but uncompleted wells (DUCs) which it plans to work through.

Ticking time bomb

Those DUCs are a time bomb for the market. After a sharp run up in drilling activity over the first half of the year, every basin has seen the number of DUCs rise. In the white-hot Permian, the number of DUCs has nearly doubled from this time last year to around 2,250, according to Energy Information Administration data. If the oil price remains at sub-$50/b, companies could start pulling back the number of rigs they have running in the field, as they have been doing in the last couple of weeks. In that case though, drilling firms would simply start shifting spending to the cheaper and quicker option of completing their DUCs, which would power robust production growth for at least several months.

Worse for Opec would be if headlines of a falling rig count, coinciding with an expected drawdown in inventories, fueled a price rally. That would give shale companies an opportunity to lock in hedges which would allow them to ramp drilling back up, starting the cycle all over again.

Not that everyone shares Lesar's view that the industry is slowing down. Schlumberger's chief executive Paul Kibgsaard says growth is largely baked in for this year. "We expect to see a steady increase in activity both in Q3 and Q4," Kibsgaard told analysts this week. As for 2018, he says things will depend on whether companies are able to continue borrowing and hedging at a rate that allows the shale industry to continue outspending its cash flow.

Even Lesar's own chief executive, Jeff Miller, seemed to temper the comments, describing the tapping of the brakes as "going from 80 miles an hour to 70 miles an hour… we still see the customer urgency".

Tapping its brakes or not, shale remains far from its breaking point.

Rigs and drilled but uncompleted wells (DUCs) in the Permian Source: Baker Hughes, EIA, Petroleum Economist
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