Hard work in 2018 for oil and gas business, balancing costs with price

Oil inventories are dropping, federal regulations are dissipating, and OPEC members are committed to limiting production.

The year ahead holds immense promise for oil companies.

Oil field services are getting expensive, labor is in short supply, and higher prices could limit demand growth. Exploration and production companies will struggle to compete in 2018.

The energy business is finally getting back to normal.

After three and a half years, the oil glut produced by horizontal drilling and hydraulic fracturing in the United States is shrinking. Inventory at the Cushing, Okla., trading hub fell to 51.4 million barrels, the lowest level since March 2015, according to the U.S. Energy Information Administration.

Shrinking inventories have triggered higher prices. In June 2017, the price for West Texas Intermediate crude was $42.53 a barrel, but this year begins at about $60.

Most analysts predict WTI will average $55 a barrel in 2018, a price high enough for the best wells to make money, but low enough to keep producers from drilling second-tier wells. Prices are nowhere near June 2014's $107, but are far better than the $26 barrel of February 2016.

President Donald Trump's administration, meanwhile, is promoting U.S. "energy dominance" by slashing regulations.

The Bureau of Land Management on Thursday repealed its rules for hydraulic fractured wells on federal land, leaving only state regulations in place. The federal Bureau of Safety and Environmental Enforcement, responsible for offshore wells, is rolling back safety regulations put in place following the 2010 Deepwater Horizon accident in the Gulf of Mexico.

"It's time for a paradigm shift in the way we regulate," said Scott Angelle, the director of the Bureau of Safety and Environmental Enforcement.

While these changes should boost U.S. oil profit margins, the Organization of the Petroleum Exporting Countries holds the real key to keeping prices high. And its 14 members along with Russia appear committed to keeping 1.8 million barrels a day off the market in 2018.

Saudi Arabia needs high prices to generate value for the shares it is selling in Aramco, the country's national oil company. Other cartel members need high prices to cover government budgets.

That leaves American shale drillers to meet new global demand. The U.S. added 1 million barrels a day of new production in 2017 and exported 954 million barrels a day of it, according to the EIA.

In early 2018, oil producers are expected to break the American record of 10.4 million barrels a day pumped in November 2017.

Higher production comes from more drilling and longer wells, though, which means higher costs.

"It will be interesting to see how cost inflation plays out against productivity gains in 2018," said Jessica Brewer, principal upstream analyst at research and consulting firm Wood Mackenzie. Drillers have already captured most of the easy savings, and per-barrel production costs are likely to rise.

Oil field services firms heavily discounted their work following the 2014 bust, and now that prices are rising, so will the cost of their services as they expect their cut.

More drilling also requires more workers, but companies are finding it hard to lure people back to the oil industry after three years of layoffs and pay cuts. Midland and Odessa, at the center of the Permian Basin, have unemployment rates of 2.6 percent and 3.4 percent respectively, and they need more workers.

"This has been an unusual year from the standpoint that it's been steady in terms of growth," Willie Taylor, CEO of Workforce Solutions Permian Basin, told my colleague at the Midland Reporter-Telegram. "We're placing 300, 400 a month out of our offices."

The other dangers of higher prices, of course, include producers getting over-excited and creating another glut, or running up prices so high they hurt demand. This time around, investors who were burned by past boom-and-bust cycles, are pressuring executives to prioritize profits over barrels.

"The shale hype seems to be over, with CEOs and management teams being held strongly accountable to deliver positive cash flow over production growth," said Chris Midgley, global head of analytics at S&P Global Platts. "Planned capital investments across oil over the next couple of years of around $300 billion show that the industry is not underinvesting and is on target."

If all market players stay on target, 2018 could be a stable and profitable year for the oil industry. But when has that ever happened?

U.S. producers are like race horses, their instinct is to compete by pumping more oil. If they can squeeze more crude out of each well for the same cost, that could create another glut.

Russian oil companies have also made their displeasure with the current production quotas clear. While President Vladimir Putin has committed them to at least another six months of restraint, they will eventually balk at letting U.S. exporters gain global market share at their expense and flood the market with cheaper oil.

The fundamental problem of excess oil production capacity remains, and that will cap how high prices can go and limit profits. The oil business may be looking up in 2018, but that doesn't mean it will be easy.