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Industry in survival mode

Sam Fletcher
OGJ Senior Writer

A recent survey of 60 producers and service company executives confirmed the upstream oil and gas industry is in a survival mode, said analysts in the Houston office of Raymond James & Associates Inc.

Those executives exhibited "a profound sense of near-term caution with [exploration and production] price expectations well below current strip pricing." They said, "The survey suggested that industry insiders are expecting 2009 oil and gas prices to average roughly 20% lower than Wall Street expectations—the first year executives have been more bearish relative to the Street since we have started this survey. Already, budgets and costs are coming down, and both are likely to continue declining through 2009. Producers are now far more focused on rates of return, especially in the face of an oversupplied gas market and potential forced production shut-ins this summer."

Raymond James analysts noted, "While the mergers and acquisitions market has been hamstrung by the credit crisis, many of the larger E&P companies with healthy balance sheets and free cash flow potential will have opportunities to rake in attractive assets at 'fire sale' prices."

Price estimates among the executives averaged $4.84/Mcf for natural gas in 2009, 25% below the Wall Street consensus; and $48.28/bbl for oil, 17% below consensus. Raymond James' current forecasts are $5/Mcf and $60/bbl; however, analysts said, "Our confidence level in a global economic rebound in the back half of this year remains low."

Budget cuts
Falling commodity prices triggered major budget cuts in the fourth quarter. Drilling budgets announced by November were tracking more than 20% below 2008 levels. "The realization that additional rounds of capex cuts were coming (more rigs needed to be laid down) became even more apparent as both the oil and gas strip prices continued to drift lower—now nearly 20% below November levels," the analysts said.

Raymond James officials reported, "Our updated 2009 E&P capital spending survey—now with over 60% of our E&P coverage universe having announced their 2009 budgets, comprising about 75% of total spending—points to an aggregate cutback in the range of 35-40%. For our coverage universe as a whole, we are currently projecting a 33% spending drop for 2009. A handful of companies are ramping down spending by as much as 70%." However, they said, "Even assuming these large cuts, total spending would still exceed what it was in 2006, when both oil and gas prices were considerably higher."

They said, "Unfortunately, we believe that spending plans must fall even further." Anecdotal evidence from conversations with industry executives suggested drilling costs will likely fall 30-40% this year with lower pipe and stimulation prices leading the largest share of the cost reductions. "If that type of well cost savings actually plays out, then a 35% reduction in E&P spending would result in only a modest reduction in drilling activity," the analysts said.

Meanwhile, oil and gas executives said their moves to conserve capital are exacerbated by the nearly frozen capital markets. "With less access to financing, at least at a reasonable cost, companies are instead looking to shore up their balance sheets or simply return capital to shareholders through share repurchases (especially at these depressed levels) or dividends," analysts said. "This financial flexibility also creates the opportunity for a few of the free cash flow-generating independents, along with the even more cash-rich integrated majors, to rake in assets at deep discounts."

Several executives indicated that they hope within 18 months to be positioned to act as "buyer of last resort" of increasingly more distressed sales of assets.

Analysts said, "With budget cuts for the most part already in place, the 'threshold of pain' discussion now revolves around the following question: At what gas price level do companies shut in production? While it was difficult to draw management teams into giving an exact figure, the overarching theme is that the majority of producers anticipate their competitors will have to shut in first."

They said, "Reading between the lines, it was fairly apparent that gas prices would need to fall to $3/Mcf (or even $2) at some point this summer before the operators that we spoke with would be willing to shut in production. Furthermore, active hedging programs may allow some of the larger gas producers to keep rigs running long after spot pricing would have made a play uneconomic. A final theme that emerged was that a number of E&P companies budgets will be determined by the drilling needed to hold leases acquired during the resource play land grabs over the past few years."

(Online Feb. 9, 2009; author's e-mail: samf@ogjonline.com)


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