Opinion: What would it take for US oil companies to increase production? A lot.

Even with oil prices above $100 a barrel and gasoline prices averaging more than $4 a gallon at the pump, the frackers show little interest in increasing production.

Companies like Devon Energy DVN,
-0.21%,
EOG Resources EOG,
-2.06%,
Occidental Petroleum OXY,
-3.49%
and Diamondback Energy FANG,
+0.39%
they have resisted increasing production. Instead, they are rewarding shareholders with hefty dividends and buybacks.

That is despite some calls increase production to help lower gasoline prices.

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

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

However, OPEC seems to be waiting to see how the United States and Iran resolve the removal of sanctions. If sanctions are lifted, Iranian oil may flood the market and OPEC may be less interested in returning to full production, says Thummel.

“There is a dance between OPEC and US producers, and that is what I think is holding US producers back,” he says.

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please investors

They may also need to test how receptive investors are to higher output levels after spending the last few years convincing buyers that companies are not back to their free-spending ways. Energy was the worst performing S&P 500 sector in the past decade as the focus was not on stock performance but on output growth. During that time, shale production grew substantially and the US’s position as a global producer of crude oil and natural gas grew significantly.

Kari Montanus, Senior Portfolio Manager of the $2.8 billion Columbia Select Mid Cap Value Fund CMUAX,
+1.56%,
whose No. 2 holding is Devon Energy, says the history of US oil producers is one of boom and bust, especially exploration and production companies.

“Even when oil was at a reasonable level, these companies spent their free cash flow and always issued stock, generating negative net free cash flow. Stocks have never outperformed sustainably,” says Montanus, adding that major oil producers like Exxon Mobil XOM,
+0.30%
and Chevron CLC,
+0.27%
could fit into that category.

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The mindset of hypergrowth at the expense of capital discipline began to change before the pandemic. However, the appearance of Covid-19 caused significant drops in oil prices and producers reduced drilling activity, which also caused reductions in personnel and many of those people found work in other sectors. That also contributed to the muted response of oil production.

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

production is increasing

Despite public companies limiting production, crude oil production has increased, according to the US Department of Energy’s Energy Information Administration. pumped about 11.6 million barrels per day (bpd) of the sticky material, 4.4% more than a year ago. Just before the pandemic, the US was close to producing 13.3 million bpd. Nearly all of that increase comes from private companies in the Permian Basin, Thummel says. Also, oil majors Exxon and Chevron said they plan to increase production in the region.

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

Part of the public companies’ hesitation to boost production is the murky outlook for oil production in both the short and long term, Montanus and Thummel say. Deferred energy futures prices suggest more oil will spill into the market as longer-term prices are lower than nearby prices.

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

Read: Here are the oil and gas companies whose methane emissions intensity is 6 times the national average (hint: they’re not the top ones)

Thummel believes that if world energy markets need US oil, producers will eventually ramp up production. But at the same time, they’re trying to figure out their niche, and that might be showing that their business models are economically sustainable. Cash flow returns for shale oil companies are typically three to four times higher than the S&P 500 at $70 per barrel of oil. Returns like that are attracting investors, including Warren Buffett, who is buying shares of Occidental Petroleum.

Oil producers are aware that “nobody wins” with oil over $100, as it eventually reduces long-term demand, he adds, with a global sweet spot for producers and consumers between $60 and $80.

Memories are also pretty fresh after two sharp drops, once oil rose to $100 in 2014 amid the OPEC price war and then the 2020 Covid rout.

“Those are pretty recent and they were devastating for the industry. The growers are just trying to navigate and prevent that from happening again,” says Thummel.

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

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