Oilfield service inflation continues to burn through upstream operators’ capex, with Callon Petroleum Co. the latest E&P to raise its budget to address price increases.

Although the pain of higher services will be offset by Callon’s forecast for more adjusted free cash flow of $900 million, the company isn’t alone. Morgan Stanley analyst Devin McDermott said about 30% of their E&P coverage has raised capex to address inflationary pressures with an average increase of 11%.

“Within that group, nearly all noted that the increase was due to inflationary impacts,” McDermott wrote in a June 6 report. “Heading into the back half of the year, we see risk for modest budget increases, mainly across the shale-focused producers that have not yet adjusted guidance to account for higher inflation.”

In 2023, Morgan Stanley sees an incremental 10%-15% upside to spending relative to 2022 for much of the U.S. E&P industry due to inflation.

“That said, inflation matters less when the industry is spending at a lower reinvestment rate of ~30% of CFO [cash flow from operations] compared to an average of ~125% over the 2015-19 time period,” McDermott wrote.

Callon’s capex jumped 10.3% to $800 million at the midpoint of its guidance from its earlier February estimate of $725 million.

In a June 6 press release, Callon reported key drilling and completion costs had increased since 2021 by about 20%. “This represents incremental inflation of approximately 10% over the 10% inflation rate assumed for the initial 2022 budget,” the company said.

It wasn’t all bad news for Callon. The company’s increase in spending has been offset by higher commodity prices that will increase free cash flow to more than $900 million, which Cowen analyst Gabe Daoud Jr. said was higher than Wall Street’s consensus of $853 million. Cowen’s own estimate was $840 million.

Joe Gatto, Callon’s president and CEO, said the company has worked with service providers over the past few months to amend and extend several key agreements and that its “visibility into our capital cost structure for the remainder of 2022 has dramatically improved.”

Callon has also taken steps to ensure reliable access to top-tier service and consumables providers for all of 2022 and is extending contracts into 2023.

With services and consumables now contracted for the remainder of the year, Daoud said Callon should have “some protection” as it heads into 2023. According to Daoud, the company is running seven rigs with plans to drop one before the end of June.

Source: Morgan Stanley

Inflationary Impacts on E&P Capex
($B unless otherwise noted)

Company Initial
Change Morgan Stanley commentary
Continental Resources $2.3 $2.6-$2.7 15% Includes $100 - $125 million inflation due to securing rigs / crews for future years.
ConocoPhillips $7.2 $7.8 8% Reflects higher partner-operated spend and inflationary impacts.
Marathon Oil $1.2 $1.3 8% Inflation largely driven by fuel, chemicals and steel.
Murphy Oil $840-$890 million $900-$950 million 7% Increase is due to inflation, productivity improvement work, and delay in nonop Brazil exploration drilling.
Devon Energy $2.06-$2.44 $2.06-$2.44 0% Could be at the high end of guidance if inflation trends persist.
Occidental Petroleum $3.9-$4.3 $3.9-$4.3 0% Could be at the high end of guidance if inflation trends persist.
Pioneer Natural Resources $3.3-$3.6 $3.3-$3.6 0% If current inflationary pressure persists, expect to be in the upper half of range.
Hess Corp. $2.6 $2.6 0% Industry inflation could add another $80-$100 million.
Coterra Energy $1.4-$1.5 $1.4-$1.5 0% Could be at the top end of guidance due to inflation.

“While service costs have increased as the industry faces significant inflationary pressures, we remain committed to a disciplined spending program with an expected capital reinvestment rate that is now tracking at less than 50%,” Gatto commented in the June 6 release. “Additionally, our free cash flow outlook continues to strengthen, and we now expect to generate over $900 million in adjusted free cash flow during the year, accelerating the path to attaining our near-term financial goals of a leverage ratio of 1x and an absolute debt level of $2 billion.”

Inflation has been a factor for public and private operators, who have said they are seeing the service costs at unprecedented levels. McDermott said inflation is expected to skew highest in the Permian Basin, where activity has risen the most.

Companies across the sector have noted cost increases across steel, labor, trucking and sand.

Dena Demboski, vice president of operations at private Permian operator UpCurve Energy LLC, said in May that casing costs have tripled and sand costs have ballooned.

UpCurve operates a 14,000 net-acre position in Reeves County, Texas, in the southern Delaware Basin. Speaking at Hart Energy’s DUG Permian Basin and Eagle Ford Conference and Exhibition in Fort Worth, Texas, on May 18, Demboski said UpCurve’s sand costs had risen from $11 to $18 a ton for regional 100 mesh sand to $60 a ton to as much as $80 per ton

“Rig rates are higher than I’ve ever seen them. If you want a full spec rig right now with three pumps and four generators, you’re looking at over $30,000 day rate,” she said. “Inflation has hit us pretty hard.”