DURING THE HALCYON DAYS of the shale revolution when revenue was streaming in and profits were soaring, energy companies were focused on growth. Even executives who had gone through previous boom and bust cycles and understood the inherit risks were tempted because the rewards were so great at the peak of the cycle. Ignoring supply and demand economics, many convinced themselves that the shale boom was different - markets would continue to demand more energy and they would be the ones to supply it.
Dick Westney of Westney Consulting Group alluded to this "bias to optimism and overconfidence" in our interview with him in the April issue of OGFJ. He preaches discipline and consistency whether it's applied to a particular project being developed or to the entire enterprise.
With this in mind, let's look at EY's recently released "US Oil and Gas Reserves Study" for 2016. The report, presented to the Houston media on June 14, analyzes US E&P results based on 2015 year-end oil and gas reserves estimates. Now, says EY, the petroleum industry has been forced to transition from growth to value due to slowed global demand for energy and abundant oil, arising mainly from a growth in production from unconventional resources in North America. Unwittingly, US shale players have become the swing producers on the international stage due to the relatively high recovery costs in shale formations compared to conventional producers, like Saudi Arabia and much of OPEC. It's a role US shale will reluctantly have to accept.
The EY report says that revenues and capital expenditures dropped 41% in 2015 - the first year since 2004 that EIA-posted monthly WTI spot prices averaged below $60 for the entire 12 months. The study analyzes E&P results for the five-year period from 2011 through 2015 for the largest 50 companies. The companies are classified into three peer groups: integrated companies, large independents, and independents. Independents were classified as "large" if their 2015 worldwide ending reserves exceeded one billion barrels of oil equivalent.
For the group, EY found that total capital expenditures amounted to $117.5 billion, and total revenues were $129.8 billion.
End-of-year oil reserves decreased 12% to 24.1 billion barrels for the study companies, and end-of-year gas reserves dropped 21% to 147.0 trillion cubic feet.
Herb Listen, assurance oil and gas leader for Ernst & Young LLP in the US, noted, "The significant spending cuts and downward reserve revisions reported in 2015 are illustrative of a structural shift taking place in the industry as a result of abundant oil. No longer are capital investment decisions driven by the pursuit of growth. Instead, the industry and those investing in it are progressively more focused on cash flow and returns."
Significantly, low prices caused revenues for the group of companies to fall 41% even as combined oil and gas production increased by 6% in 2015.
"Amid low prices, declining hedges, and the drastic drop in revenues, many US producers are experiencing rating downgrades and lower reserve base borrowing limits and, consequently, less cash flow and liquidity," said Mitch Fane, oil and gas transactions leader for Ernst & Young's southwest region. "Already, bankruptcies and restructurings have increased, as have dividend and interest payment deferrals. This trend is expected to continue amid lower-for-longer oil."
As noted previously, capital spending also saw a marked decline across the board in 2015.
Amid less M&A activity than many projected, proved and unproved acquisition costs dropped 79% to $5.4 billion and 63% to $10.0 billion, respectively.
"While many expected an uptick in asset sales due to oil and gas companies' need for capital, the most valued E&P assets in this current environment are frequently the lifeblood of their companies' operations," said Fane. "As a result, the bid-ask spreads for quality, producing properties and declining values of some non-producing properties have hindered transactions and private equity investment thus far."
Declines in exploration and development spending of 28% and 31%, respectively, were evident in the study companies' reduced drilling activity. The number of net wells drilled declined 41% (exploratory wells) and 31% (development wells) in 2015.
Exploration spending totaled $17.1 billion in 2015, compared with $23.6 billion in 2014. Independents led the charge by reducing their exploration spending by 39%. Development spending declined from $122.8 billion in 2014 to $84.7 billion in 2015, as all of the study companies decreased their development spending.
"Independents and large independents accounted for the most significant cuts to exploration and development spending, while the integrateds actually increased exploration spending by 9%, according to Listen. "Looking forward to 2016 and 2017, the full range of US producers will face continued pressure to reduce spending if prices remain at current levels."
So what were EY's conclusions? That the shift to abundant supply that exceeds demand has created a low-price environment for both oil and natural gas. This environment has made its mark on US upstream companies in 2015 with significant declines in revenues, capital expenditures, and reserves. Despite the industry's tremendous success in identifying and developing new reserves in the past decade, this "era of abundance" will require companies to transform in order to survive and prosper.