RAYMOND JAMES reported there was "mile-high optimism" among producers at EnerCom's well-attended annual Oil & Gas Conference, Aug. 14-18, in Denver. CEOs from one company after another were overwhelmingly positive in their outlook for the E&P space entering 2017 and beyond. The executives believe rising productivity and increased capital efficiency are a sign that an upstream rally is imminent and stock prices are climbing. A number of analysts who follow the industry support this position.
Deal-making activity would seem to bear out this level of confidence. Houston-based PLS Inc., reporting in this issue of OGFJ, say that upstream transactions are strong, particularly in the Permian Basin where "white-hot activity" leads in terms of deal flow, size, and valuations. In the past month, the Permian alone accounted for 69% of all US deal activity and 40% of global activity. PLS's Andrew Mason Dittmar refers to West Texas as a "juggernaut play" with most A&D activity clustered around two main areas - one in the Midland Basin centered on Martin and Midland counties and a second in the southern Delaware Basin along the Pecos River dividing Ward and Reeves counties. The southern Delaware, in particular, has seen increased activity this year.
Activity in the US onshore sector definitely seems to have accelerated in recent months. Management teams appear to have reluctantly come to terms with lower commodity prices than they would like. Their focus is on controlling costs, cutting out the fat, and improving efficiencies in various ways - drilling longer laterals, using more proppants, etc. Many companies that were overleveraged have recapitalized and are moving ahead.
In sum, the industry sees commodity prices starting to stabilize and is determined to make it through the nearly two-year (so far) struggle over declining prices. Their view is that the future looks increasingly bright.
Unfortunately, the financial community is not totally on board with this level of optimism. Moody's Investors Service issued an in-depth report on the sector on August 23 with the headline - "No Relief in Sight for Stretched Balance Sheets in 2016."
Moody's believes that high leverage will continue to hinder the North American E&P sector despite recent improvements in commodity prices because cash flows are still mismatched to debt loads for most E&P companies.
"E&P companies have been seeking remedies to become more efficient in finding and replacing reserves, reducing costs, and preventing their leverage from creeping higher," says R.J. Cruz, vice president and senior analyst for Moody's. However, in an analysis using two different price scenarios for the second half of 2016, Moody's found that key E&P metrics are likely to deteriorate further this year due to lower total production for the sector and a high level of aggregate total debt compared to other periods.
In addition, Moody's expects EBITDA for the companies it evaluated to decline in either its lower price or higher price scenarios in spite of actions to fortify balance sheets and bolster cash levels.
"Leverage among the E&P companies we surveyed has more than quadrupled since 2011, and will continue to get worse in 2016," says Cruz.
Writing for Rusty Braziel's RBN Energy blog, industry analyst Nick Cacchione says that upstream capex may have bottomed out and he sees signs of growth emerging. In the second quarter, he says North American E&P companies did little to change the steep reductions in 2016 capital budgets they unveiled around the first of the year. Total 2016 finding and development spending for 46 top US producers was an estimated $41 billion, down 51% and 70% from investment in 2015 and 2014, respectively.
Cacchione says that second-quarter reports so far confirm the initial guidance of a 4% production decline in 2016 after 7% and 6% increases in 2014 and 2015. Taking an in-depth look behind the headline numbers, he says that the industry may be poised for a turnaround in drilling activity later this year and into 2017.
An important sign of the apparent turnaround is the 20% increase in the US drilling-rig count since the last week in May. That gain reverses two years of steady weekly declines in the rig count, although the latest count of 496 rigs represents a quarter of the number operating at the peak in mid-2014. The Permian Basin accounts for the majority of the new rigs.
So how is the rig count climbing if capital budgets aren't growing? One part of the answer is the dramatic decrease in drilling costs, says Cacchione. He estimates that overall drilling costs have declined about 40% since 2014. An average Bakken well that cost nearly $10 million to drill in 2014 today costs only about $6 million. A well in the Permian that cost over $8 million to drill in 2014 now costs only $5 million to drill. In the Eagle Ford, a well that costs about $4 million to drill today would have cost $7 million in 2014.
For the rest of 2016, he expects capital budgets to remain relatively flat but drilling activity to continue to increase, boosting production forecasts for early 2017. He concludes that the long-term trend will depend on whether this increased output will dampen the more positive outlook for oil prices.