Surging oil prices will test the resolve of companies to cut back on drilling

In 2022, Exxon and Chevron plan to increase oil drilling in the Permian basin in Texas.
In 2022, Exxon and Chevron plan to increase oil drilling in the Permian basin in Texas.
Image: Reuters/Angus Mordant
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The price of oil is close to $90 per barrel, its highest point since October 2014, pumped up by lower-than-expected supply and the risk that conflict in Ukraine could lead to cut-offs from Russia.

Oil companies rebounded strongly in 2021. On Jan. 28, Chevron posted $15.6 billion in annual earnings, its highest since 2014. On Feb. 1, ExxonMobil followed suit (pdf), also posting its best year since 2014. Companies have cut costs and repaid debts during the pandemic, but some analysts fear they could slip back into their old habits, with potential consequences for shareholders and climate change.

“Company managements are notoriously stubborn, shortsighted, and delusional,” warns Ed Hirs, an energy economist at the University of Houston.

Oil companies changed strategy during the pandemic

2022 could be even better. The International Energy Agency expects global oil demand to exceed pre-pandemic levels by the end of the year. Chevron CEO Mike Wirth predicted last week that the price could pass $100 within the next few months.

Throughout the oil industry’s 150-year history, high prices meant one thing: More drilling. But when the price inevitably fell back to earth, oil companies were left with debt and unhappy shareholders.

In the last decade, the energy sector was consistently the worst performer in the S&P 500, but that changed during the pandemic. With prices at record lows, companies slashed spending on production, and channeled cash into paying off debt and raising shareholder dividends to keep investors from jumping ship.

The market rewarded them: In 2021, energy was by far the best-performing sector in the S&P 500. Now, with prices surging, fiscal discipline is still in vogue; the oil industry in Texas, for example, has added back only about 30% of the jobs that were lost during the pandemic.

Exxon has big plans to expand oil drilling in 2022

Chevron’s earnings report boasted all the stats shareholders are after: Capital spending cut in half from 2019, and free cash flow at a record $21.1 billion. The company boosted its dividend 6%, and spent $13 billion paying down debt. Although it plans to increase the number of wells operating in the US Permian basin by 50% in 2022, the company projects that total oil production will either stay flat or fall slightly as it allows drilling contracts in Indonesia and Thailand to expire.

Exxon paid down $20 billion in debt. It shaved $2 billion off annual operating costs through corporate restructuring (including thousands of layoffs) and is consolidating its refining and chemical businesses. It announced a plan to buy back $10 billion in shares, and sold off more than $3 billion in nonessential assets. Its share price has almost doubled from this time last year.

But Exxon also announced big drilling expansion plans for 2022, saying it will boost capital spending up to 45% to $24 billion, which would be an increase from pre-pandemic levels. Bryan Benoit, national managing partner for energy at the consultancy Grant Thornton, said Exxon’s strategy is likely representative of what to expect from US oil and gas companies as a whole this year (if not at the same scale).

“We anticipate pent-up demand and thus a significant increase in spending, possibly as high as 20% over 2021 levels, but most likely between 15-16%,” he said.

Spending on climate-related projects will also get a slight boost. Chevron’s New Energies division will have a budget of $10 billion through 2028, the company said, compared to $11.7 billion in 2021 alone. Exxon said it will spend about $1 billion in 2022 on low-carbon projects, compared to $24 billion on drilling.

Oil companies disagree about when peak oil will arrive

It makes sense that both companies are keen to ramp up activity in the Permian, where the cost of production is relatively low and can be scaled back down again relatively easily when prices slide, said Axel Dalman, an oil and gas analyst at Carbon Tracker Initiative.

But Exxon and others are still moving ahead on a number of riskier long-term projects that won’t start production for years and rely on what is probably an overly optimistic outlook for oil prices, he said. Today’s high oil prices, in other words, could form a kind of trap that entices investors and CEOs, but leaves hundreds of billions of dollars stranded later in the decade as governments police emissions more aggressively, and the economy pivots away from liquid fuels.

“The industry’s track record isn’t great in terms of being conservative and planning for a lower-price future,” he said. “That’s something investors should be very careful about.”