This is despite some calls for increased production to help lower gasoline prices.

So what would it take for US shale companies to increase production? It turns out that several factors are at play.

For starters, the industry faces a dilemma, says Rob Thummel, portfolio manager and senior managing director at Tortoise, a firm that manages about $8 billion in energy-related assets. US producers are waiting for the Organization of the Petroleum Exporting Countries (OPEC) to return to full production. He suggests it could happen this year.

Still, OPEC appears to be waiting to see how the United States and Iran will engineer the lifting of sanctions. If the sanctions are lifted, Iranian oil could flood the market and OPEC may be less interested in returning to full production, Thummel says.

“There’s this dance that’s played out between OPEC and American producers, and that’s what I think is holding American producers back,” he says.

Read: Landmark SEC ruling on climate change could require companies to account for pollution they don’t directly create

Pleasing investors

They may also need to test investors’ receptivity to higher production levels after spending the past few years convincing buyers that companies haven’t returned to their free-spending habits. Energy has been the worst performing sector in the S&P 500 over the past decade as the focus was not on stock performance but on output growth. During this period, shale production increased dramatically, and the United States’ position as a world producer of crude oil and natural gas increased significantly.

Kari Montanus, lead portfolio manager for the $2.8 billion CMUAX Columbia Select Mid Cap Value fund,
+1.56%,
whose second position is Devon Energy, says the history of US oil producers is a checkerboard, especially exploration and production companies.

“Even when oil was at a reasonable level, these companies spent their free cash flow and still issued stocks, generating negative net free cash flow. Stocks were never outperforming sustainably,” says Montanus, adding that major oil producers such as Exxon Mobil XOM,
+0.30%
and Chevron CVX,
+0.27%
could fall into this category.

Read: The S&P energy sector jumped more than 50% last year – so how have green funds been able to keep pace with the stock market?

The mindset of hyper-growth at the expense of capital discipline began to change before the pandemic. However, the outbreak of Covid-19 caused a significant drop in oil prices and producers reduced drilling activity which also led to workforce reductions and many of these people found work in other sectors. This also contributed to the muted response of oil production.

“Oil and gas drilling still requires many manual processes. There’s technology associated with it, but it still requires people and there just aren’t as many people in the future. That’s kind of how we got here,” Thummel says.

Production increases

Despite the plateau in production by state-owned companies, crude oil production is on the rise, according to the US Department of Energy’s Energy Information Administration. The most recent data shows the United States pumped about 11.6 million barrels per day (bpd) of the sticky stuff, up 4.4% from a year ago. Just before the pandemic, the United States was close to producing 13.3 million bpd. Almost all of this increase comes from private companies in the Permian Basin, says Thummel. Additionally, oil majors Exxon and Chevron have said they plan to increase production in the region.

Read: Biden to resume federal oil and gas development under tougher rules as ‘social cost of carbon’ challenged in court

He expects to see an additional 500,000 barrels per day this year on top of that total, but the United States won’t reach pre-Covid levels until 2023. Thummel also notes that it may take around six months for companies to significantly increase production.

Part of the reluctance of state companies to increase production is due to the bleak prospects for oil production in the short and long term, according to Montanus and Thummel. Delayed energy futures suggest that more oil will pour into the market as longer-term prices are lower than nearby prices.

These producers may also be trying to figure out where they will be in the future. There is a push for energy independence and energy security for oil-producing countries, but energy independence is also a lot like renewable energy, which is growing. The rise of environmental, social and governance (ESG) investing means some people are refusing to buy fossil fuel companies, Montanus adds.

Read: Here are the oil and gas companies whose methane emissions intensity is 6 times the national average (hint: these aren’t the majors)

Thummel thinks that if global energy markets need US oil, producers will eventually increase production. But at the same time, they’re trying to find their niche, and that just might prove that their business models are economically viable. Cash flow returns from shale oil companies are typically three to four times those of the S&P 500 at $70 a barrel of oil. Such returns are attracting investors, including Warren Buffett, who is buying Occidental Petroleum shares.

Oil producers are aware that “no one wins” with oil above $100 because it ends up reducing demand in the long run, he adds, with a sweet spot for producers and consumers at the globally between $60 and $80.

Memories are also quite fresh after two violent crashes, once after oil rose to $100 in 2014 amid OPEC’s price war and then the Covid rout in 2020.

“These are quite recent and have been devastating to the industry. The producers are just trying to navigate and prevent this from happening again,” says Thummel.

Debbie Carlson is a MarketWatch columnist. Follow her on Twitter @DebbieCarlson1.

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