Shale gas drillers expect rising prices to offset inflation of up to 20% in 2022

Tight controls on spending and drilling boosted first-quarter cash flows for shale gas producers, but inflation started to drive up production costs.

The average price of NYMEX Henry Hub futures contracts rose 65% in the first quarter of 2022 compared to the first quarter of 2021, and the soaring prices combined with two years' worth of belt-tightening to pump up cash flows. Wall Street analysts predicted that much of the cash will continue to be returned to shareholders through share buybacks and dividends.

However, shale gas executives warned on earnings calls that higher costs for steel tubing, sand and labor have begun to nibble away at these returns. They said inflationary pressures will probably increase this year before they slacken in 2023.

"We are seeing significant inflation in the oilfield," Coterra Energy Inc. President and CEO Thomas Jorden told analysts on a May 3 call. "Pricing for drilling rigs, completion crews, fuel, sand, labor, oilfield services and trucking are all moving upward."

Jorden predicted that inflation would increase the company's costs by 15% to 20% in 2022, but Coterra maintained its 2022 capital spending guidance of $1.45 billion at midpoint.

Higher prices for labor and materials have had similar effects in both major U.S. shale gas plays — Appalachia's Marcellus Shale and the Haynesville Shale in Louisiana and Texas — Southwestern Energy Co. Executive Vice President and COO Clayton Carrell said on an April 29 call.

"There are some localized flare-ups that can occur with trucking and with some last-mile logistics, but in general there's not a big difference for us," Carrell said.

Inflation may cut both ways for oil and gas producers, analysts said — increasing production costs but attracting more investor interest in the sector as a hedge against economywide inflation.

"We believe investors can no longer ignore the sector's capital returns, attractive valuations and positive estimate revisions," Siebert Williams Shank LLC oil and gas analyst Gabriele Sorbara told clients May 12. "Inflationary concerns are likely to pivot capital inflows to the resource sector and no sector is better understood than fossil fuels for a hedge on inflation."

Sorbara said he is not worried about rising costs, which he expects will persist into 2023, because higher prices for oil and gas will keep profit margins intact.

"Absent a global recession, energy as [a] whole will likely continue to re-rate higher into year-end as we expect interest in the space to continue to grow given strong free cash flow yields, clean balance sheets, and robust dividend yields in many cases complemented by buybacks," Tudor Pickering Holt & Co.'s managing director for equity research, Matthew Portillo, said.

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