For shale drillers, rising oil prices also come with rising costs

U.S. shale drillers that proved resilient during the oil downturn face a new test in 2017: Can they make money producing more now that prices have stabilized?

The price of crude is hovering just below $55 a barrel—the level many energy companies said they needed to make a profit—and that is setting off a race to drill again. Producers boosted U.S. oil output to nearly 9 million barrels a day, pumping an extra 500,000 barrels a day in the past three months. The additional American production is more than the volume that Saudi Arabia committed to stop producing to help shore up global crude prices.

But the cost middlemen charge companies to help them tap new wells is rising along with the new activity. That is threatening to wipe out some of the savings the industry gained by belt-tightening during the bust.

Shale companies have put more than 90 additional rigs back into the field in recent weeks, after a November agreement by Russia and the Organization of the Petroleum Exporting Countries to curb global output boosted oil prices.

However, the cost to hire an experienced drilling crew and source critical oil-field supplies, including the sand used in hydraulic fracturing, has surged between 10% and 20% this winter, experts say. Shale companies could face even higher prices if crude keeps climbing to $60 a barrel, they add.

Much of the cost savings that U.S. producers realized during the downturn came at the expense of oil-field-services companies, which have made it clear they intend to raise prices when demand for their help rises.

Halliburton Co. has likened negotiations with its customers to a “barroom brawl.” Hundreds of small to midsize rivals that run rigs, truck water and pipe in and out of the field and provide the labor to frack wells are also trying to charge more in the new year.

“What we’re seeing at the moment is a massive industry renegotiation,” said Colin Davies, a senior analyst at AB Bernstein and former vice president of corporate strategy with Hess Corp.

Though a recovery remains tenuous, the U.S. shale sector hit an important inflection point in the fall, after two years in which companies hemorrhaged cash as oil prices plunged from over $100 a barrel in the summer of 2014 to less than $30 a year ago.

Sixteen shale producers, including Apache Corp., Continental Resources Co. and Marathon Oil Corp., managed to slash costs enough to generate free cash flow during the third quarter of 2016, according to a Wall Street Journal analysis of data compiled by S&P Global Market Intelligence on the 40 largest U.S. oil and gas producers by market capitalization.

That means more shale producers are living within their means than at any point in the last five years. But whether more can prosper this year, when oil is expected to stay between $50 and $60 a barrel, remains to be seen.

Shale companies like Carrizo Oil & Gas Inc., a driller active in Texas, Colorado and Pennsylvania, have tried to entice service providers to maintain current pricing under long-term contracts. They have met some resistance, said Chip Johnson, Carrizo’s chief executive.

“Service companies don’t really want to lock in today’s prices for any longer than they have to,” he told an industry conference audience in Houston in November.

Kenneth Shore, vice president of Tec Well Service, Inc. in Longview, Texas, said that at the peak of the oil boom, Tec Well charged $325 an hour to drill wells, but dropped that to around $200 as crude prices slumped.

Mr. Shore recently quoted an oil producer customer a rate of $220 per hour to operate a rig in the Permian Basin because there was no experienced crew on hand and he knew he would be unable to lure workers back without boosting their salaries.

The client agreed, and Tec Well announced an 11% wage increase.

Producers have had “service companies working for them below their cash cost,” said Mr. Shore, adding that “all of our competitors went bankrupt, every single one of them”.

Sand mines are pushing up prices, hoping to get 20% or more for the fracking ingredient used to help prop open underground fissures and allow oil to flow to the surface.

Until recently sand mined in Wisconsin hovered around $20 a ton, but a company recently reported a purchase at $30 a ton, according to Simmons & Co. International. The Houston energy investment bank is forecasting demand for frack sand could jump 60% to 60 million tons in 2017 as shale producers try to coax more from every well by using more sand and fracking wells more often.

Those kinds of advances in production techniques are what helped many U.S. shale companies make drilling wells economic at around $55 a barrel, down from $90 just two years ago. So rising prices for sand and other services could increase the price they need to break even, analysts say.

In Oklahoma’s Scoop formation, one of the hottest current drilling areas in the country, a typical well can now make money at $51 oil, according to Simmons. But factoring in a 15% to 30% escalation in service costs, those same wells would need between $57 and $63 a barrel to break even, the bank estimates.

New wells are only one of the ways U.S. drillers stand poised to pump up production. More than 5,200 drilled-but-uncompleted wells, known as DUCs, are waiting to be pumped. With initial drilling costs already spent, most can now be completed and pumped profitably at $40 barrel, said Ryan Duman, a senior analyst with consultancy Wood Mackenzie.

“The DUCs are well into the money these days,” Mr. Duman said.