Where Is the Energy Sector Heading?

VAN ECK: For energy, let’s follow up on that. You talk about the business model of shale companies. Shale is a new phenomenon, so the investors in the industry are still trying to figure out their operating structure, right? Where are they in that process and where do you think the successful ones will end up?

REYNOLDS: I think it’s really important to put where we are in context of an industry that is a 20-year-long industry. We have spent 10 years in shale investing. We grabbed the resource: that was the acreage grab. We invested early on in the infrastructure: pipelines and tanks. We drilled inefficiently early on because we had to assess and frame where the resource base is. All that’s done, as an investment phase, relatively inefficiently. Now we’re inflecting into the harvest mode. You put 10 years of investment in, now we’ve got at least 10 years of harvest to come. The interesting part about that is, you get a steady growth rate with a lot of visibility. But importantly, and this is what I think the market really wants to see, you start to see returns really ratchet up in that timeframe.

The energy sector has been on a wild ride since the presidential elections. The sector was led by higher inventories and overproduction of crude oil, which affected the earnings for energy companies. Toward the second half of 2017, OPEC’s production cuts and global economic growth boosted global demand and kept a lid on production. Some of President Trump’s plans for the energy sector also helped the sector’s performance. It gained 39% in 2017.

Despite enjoying gains last year, the sector has plummeted so far in 2018, as the chart above shows. As of March 20, the sector has declined 7.5% this year.

Many investors in the energy sector are keen on US shale companies focusing on returns rather than higher output. Shale producers in the United States now face a challenge of whether to take advantage of higher oil prices or return cash to shareholders. Some of them have also started following capital allocation strategies like precious and base metal companies. Many US shale companies have begun cutting down costs and drilling more efficient wells.

A Reuters article in December reported that shale companies are now focusing on delivering both higher output and returns. The Oklahoma-based Energy Company Devon Energy Corporation’s (DVN) CEO, Dave Hager, commented that the company is now focusing on a disciplined approach to capital allocation. The company expects to spend less on new wells and boost oil production by 20% in the current quarter from the Permian and Oklahoma shale plays.

Whiting Petroleum Corporation (WLL), Occidental Petroleum (OXY), and Pioneer Natural Resources Company (PXD) are also expecting a jump in production. In an article in S&P Global Platts, Trisha Curtis, co-founder of energy analytics and advisory firm PetroNerds, mentioned that most shale companies wouldn’t be generating positive free cash flow until at least mid-2018, as most are keen to increase output in 2018.

Meanwhile, 2018 could be a year to see if US shale output will weigh on global markets.