The plunge in oil prices, and a lack of support from the natural gas complex, should result in sober forecasts as North America's producers discuss their expectations for 2015 during upcoming quarterly conference calls. Prognosticators, however, see little reason for optimism until late 2016.
One thing they all have in common. No matter what size or where an exploration and production (E&P) company operates, nothing is in sharp focus since the collapse in global oil prices.
Freeport-McMoRan Inc., scheduled to report quarterly earnings on Tuesday, is a big Gulf of Mexico producer. Hess Corp., which operates onshore and off, reports on Wednesday, with Thursday unveiling results by Royal Dutch Shell plc, Occidental Petroleum Corp. and ConocoPhillips. Chevron Corp. delivers its results on Friday.
In light of capital expenditure (capex) cuts that have been coming at a steady pace by many of the North American independents, analysts don’t expect upside surprises. On Friday, Wells Fargo Inc.'s team lowered its gas price outlook through 2016. Tudor, Pickering, Holt & Co. (TPH) slashed the oil price outlook.
The outlook for natural gas is "bad," according to Wells Fargo. There's just too much supply, even with an expected reduction in associated gas from reduced oil drilling.
$3.00 NatGas Prices in 2016
This year, Wells Fargo expects gas prices to average $2.85/Mcf, versus an earlier view of $3.70. For 2016, prices are seen averaging $3.00 versus $4.15. The long-term forecast was revised to $4.00 from $4.50.
"The U.S. E&P industry is at the front end of what will be a structural transformation," according to Wells Fargo analysts, who also cut the outlook for E&Ps across the board. "Executives have finally begun to accept a new near-term pricing reality, including very bearish natural gas fundamentals, and focus has moved to the balance sheet."
For those attempting to hang on until oil prices strengthen, rescue won't come for awhile, according to TPH. Analysts Brandon Blossman and Matt Portillo updated their global oil supply/demand model using their current U.S. rig count forecast. The resulting production expectations drove the oil price forecast to $50/bbl West Texas Intermediate through the first half of 2015. The forecast indicated that prices would move sharply to $90/bbl by the end of 2016.
"We see a $90/bbl price tag as necessary to incent a sharp turn in then-contracting global oil supply," said the duo. Their forecast indicated that the drop in the domestic oil rig count pulled global supply/demand back into balance by the end of this year, with the oil price moving off its lows earlier in 3Q2015 "as the supply growth taper becomes increasingly visible."
TPH expects to see almost 800 oil rigs dropped in the United States this year, with 1.5 million b/d of 2014 total supply growth dropping to 500,000 b/d in 2015. As important, they see supply transitioning to contraction by 2016, averaging a 200,0000 b/d drop over the year.
Wood Mackenzie assessed the challenges facing the majors, independents and international oil companies (IOC) and said Friday several themes would shape the energy complex this year led by -- no surprise -- the financial challenges of low prices.
“Lower oil prices pose the biggest threat to oil and gas industry earnings and financial solidity since the financial crash of 2008," according to Wood Mackenzie. "Brent is now 50% below the 2014 average of US$99/bbl. More evidence of how this is affecting performance and strategy will appear in the 4Q2014 results and further pared-back 2015 investment plans.
"The financial performance in 1Q2015 will deteriorate, as the impact of a full quarter of low price realizations flows through to earnings. Crude hedging programs will provide temporary protection for some for a quarter or two," with lagging oil-index liquefied natural gas and European gas contracts "start to adjust to December-January crude prices by 3Q2015."
Debt management is a "critical priority," according to the consultancy. "Total net debt for the 46 IOCs in Wood Mackenzie's corporate service has risen by 20% ($53 billion) since 2010 (excluding conglomerates). The cost of new capital for smaller companies will rise sharply in 2015. Asset write-downs will lead to higher leverage ratios and increased financial stretch for some companies. Refinancing could prove difficult in certain cases and covenants based on reserves, cash flow and market cap ratios could come into play."
An Estimated Capex Reduction of $170 Billion
Wood Mackenzie is estimating producers need to reduce capex by $170 billion, or 37%, to maintain 2014 net debt levels at a Brent price of $60/bbl.
"Cuts will be spread across: investment in new projects; exploration budgets; operating costs; and shareholder distributions," said the consultants. "In 2013/2014 companies were making strategic choices related to messaging around value versus volume as they tried to increase their appeal to investors; capital discipline in 2015 will be less about choice and more about survival for some players. The effects could last well beyond 2015."
This year won't be a "vintage year for exploration, but a window of opportunity will open to capture high-impact acreage and discovered resource opportunities," Wood Mackenzie analysts said. "Play-opening discoveries will be few and far between as scarcer capital is reallocated toward appraisal and higher returning incremental prospects. Exploration budgets will fall sharply, although lower costs will be an offsetting factor.
"But a big unknown is how much and for how long costs will fall," with many companies holding fire "on expensive frontier drilling in anticipation that lower drilling and appraisal costs could materially improve full cycle economics. The opening up of Mexico will also herald a new wave of resource access and an opportunity" for the operators that are financially strong, i.e. majors, large-caps and IOCs that would be able to establish new growth platforms for the next upcycle.
For many U.S. E&Ps, whether they work offshore, onshore or both, it's a slide into "maintenance mode," according to Fitch Ratings. Analysts see a troubling picture for high yield (HY) energy credit risks following an "accommodating" financial and commodity price environment through the first half of 2014. Now, "HY spreads have increased dramatically and the HY energy bond market essentially closed in the fourth quarter...Sustained lower oil prices in 2015 would have a dual effect on HY E&P companies, with lower cash flow leading to higher leverage, and delayed drilling plans challenging longer-term production growth."
Levered companies face big hurdles to attract capital, with Fitch expecting them to "go into maintenance mode in the near term, drilling required wells to maintain production and hold acreage in the most economic areas in an attempt to preserve adequate liquidity. HY E&P cash balances are typically low, with firms funding new drilling largely through revolver borrowings. Bank credit facilities will take on increased importance in 2015 as a liquidity bridge towards operating cost reductions and, potentially, higher oil prices in 2016."
Large Companies Also Hit
It may take six months or longer to stem surging onshore gas and oil production, with the most insulated seen as the oil majors and large-cap independents. However, the big operators also face risks, according to Credit Suisse. ExxonMobil Corp., the largest domestic gas producer, and Chevron were downgraded because "on the other side of this oil price recession, the group will have less production, more debt and lower upstream cash margins than they were projected to earn six months ago." The firm on Friday cut its price target on ExxonMobil to $82 from $90 and rated it "underperform," and Chevron's target was cut to $115 from $130 with a "neutral" rating.
ExxonMobil, said Credit Suisse, has "targeted to grow its volumes modestly" by 2017, "as upstream margins expanded, with some investments still to pay off in the downstream and with asset sales..." However, its cash neutral oil price has fallen. Chevron faces a $10 billion impact for Australian liquefied natural gas export projects, even though they eventually should deliver a "long lived cash flow stream..."
BP plc has been restructuring and downsizing for almost five years, but more cutbacks are expected, CEO Bob Dudley said at the World Economic Forum in Davos, Switzerland. Shell's CEO Ben van Beurden also has made it clear that the U.S. onshore holds no big attractions at this point. However, if Big Oil companies cut back spending as expected, the effect should cascade through the global energy complex and dent future supplies.
The industry "needs to put on stream about 50 million b/d of new production by 2030, just to meet demand," said the Credit Suisse analysts. To do that would require, within 15 years, "replacing roughly 60% of current oil supply," or about the equivalent of "five times the current output of Saudi Arabia...To put that in context, U.S. shale, with a backdrop of $100/bbl oil prices and rising industry debt levels, has added 5 million b/d in four years. We believe the rest of the world's resources will still play an important role in price formation over the medium term."
Standard & Poor's Ratings Service analysts said they weren't forecasting much activity on the merger and acquisition front among E&Ps until oil prices stabilize. However, Ernst & Young LLC (EY) consultants think the drop in oil prices could force some operators to sell.
"Looking forward, the oil price collapse will spur increased transaction activity during 2015 for a couple of reasons," said EY's Mitch Fane, U.S. oil and gas transaction advisory services leader.
"On one hand, upstream companies with strong balance sheets operating in low-cost basins will be well-positioned to not only weather the dip in prices, but also scoop up assets from those with less liquidity or more capital-intensive assets. At the same time, companies across the oil and gas segment will be pressured to review and reshape their portfolios to optimize capital and create higher returns."