Cycle sinking 'deeper, longer'

Sam Fletcher
Senior Writer

This down-cycle for oil and gas will be "deeper and longer than most expect, with oil consumption falling for 3 years—the longest period since the early 1980s," warned analysts at Friedman, Billings, Ramsey & Co. Inc. (FBR) in Arlington, Va.

In a separate report, Adam Sieminski, chief energy economist, Deutsche Bank, Washington, DC, said, "We believe the potential for global oil demand to be even lower than the most bearish of current forecasts. We expect this will prompt the Organization of Petroleum Exporting Countries into further [production cuts] at some point in 2009. However, we are reassured by the ongoing flattening in the crude oil curve, which we expect will help lift oil prices into the second quarter."

FBR analysts said, "The steep drop in oil prices and limited access to capital will further reduce exploration and production [spending]. Deflation will take years, not quarters, to set in; thus, we expect a U-shaped cycle, not a V-shaped recovery as some expect." They expect the worst spending downturn since the early 1980s, but not as severe. Consumption declines should be similar to the 1980s' declines in duration, but not as deep. In 1979-84, oil and gas consumption decreased 6.5% and with capital spending falling 59% from 1981 to 1987. FBR is expecting consumption to decrease 2.7% from 2008 to through 2011 and foresees a 33% drop in capital expenditures over the same period.

Natural gas blues
In Houston, analysts at Raymond James & Associates Inc. reiterated, "Gas is going to be ugly, and NGL production levels aren't winning any pageants either. Due to declining refinery utilization and weak industrial-consumer demand for NGL feedstocks, NGL margins have remained depressed, and average NGL production levels are down 600 MMcfd on a year-over-year basis since the beginning of withdrawal season."

Raymond James analysts expect improved processing margins during the second half of this year could increase production, "thereby narrowing the year-over-year gas supply level from current levels of 600 MMcfd to 300 MMcfd looser."

FBR analysts said, "The US natural gas market can produce more with fewer resources due to the new methods of horizontal drilling, multistage completions, and shale formations." As a result, they expect a downward shift in long-term spending necessary to maintain production. "Non-shale capex will be lower for longer," they said. "Furthermore, operators with international or domestic deepwater oil opportunities should further shift their investments toward those projects. We expect US operators to spend only 80% of their cash flow in 2009, 67% in 2010, and 80–85% long term, as projects are not economical at a long-term gas price of $4.50/Mcf."

FBR analysts noted, "Improved technology and methodology are making a large quantity of low-cost shale gas economical. Lower demand and excess capacity are also lowering service costs. This should lower the weighted-average marginal cost of production 20% in 2009 to below $3[/bbl]. Even with more than a 60% reduction in gas capex, the natural gas market will not be balanced in our opinion. There could need to be another 25–30% drop in gas capex in 2010 to balance the market. The 2008 capex level is unlikely to be seen for many years."

Too many rigs
According to FBR analysts, "There has been a structural shift in natural gas production, and the casual relationship of 'three times as many rigs needed to maintain production' should be dispelled. The dramatic increase in lower-cost shale gas and more productive completion methods should reduce the long-term call on conventional drilling rigs."

FBR said 1,000 US land rigs need to be retired. "We expect the natural gas rig count to average 882 rigs in 2009 and 782 in 2010 as capex is cut to balance the natural gas market. In 2011, we expect the US land rig count to average 1,220. With more than 2,500 rigs marketed at the peak of the 2008 cycle, including 750 new builds and not including 100 under construction new builds, we believe 1,000 rigs need be stacked for land rig margins to rise above cash costs. Utilization for 2009 and 2010 should be around 40% and 74% long term after 1,000 rigs are stacked," they said.

"Over the last several months, the market has declined at an increasingly rapid pace for both jack ups and deepwater [rigs]. Tender activity has dried up considerably," said FBR analysts. "We expect deepwater day rates to fall on average by 42% from peak rates while we expect jack up day rates to fall on average by 53% from peak rates."

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

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