To paraphrase Mark Twain, the reports of the death of U.S. exploration have been greatly exaggerated. So says Wood Mackenzie Ltd., whose research on the near-term financial risks of a group of 26 top independents determined that it's more hype than fact.
For instance, extensive research about the peer group concluded that concerns surrounding the October reserves-based lending redeterminations were exaggerated. Most companies in the 26-member exploration and production (E&P) group have rising absolute debt levels, but "at least two-thirds of Lower 48 production is attributable to companies with no resource-based lending exposure at all, or have no redeterminations until 2016."
Of those larger E&Ps with near-term debt redeterminations, Wood Mackenzie estimated most can accommodate a borrowing-base cut of more than 50% before their situation becomes imminently critical.
"We anticipate discomfort in the coming months and expect some more companies will inevitably fail, which is clearly a catastrophic event for lenders and equity holders," said corporate analysis research director Fraser McKay. "However, most of these companies will be small, with pre-existing structural portfolio issues. "Even in the worst case scenario, the assets of these companies will be salvaged through restructuring or assets sales; creditors will keep wells producing as long as possible. The strategic actions and cash flow neutrality goals of the largest producers in the sector will have a far greater impact on capital spend and therefore supply."
The larger producers and the majors, which account for most of the upstream investments and production in the United States, have the required flexibility to remain going concerns "through the near term at the very least," according to one of two reports recently issued, "U.S. Independents: How Strong, For How Long?"
Senior analyst Andy McConn, who works in the corporate research department in Houston, discussed the findings with NGI’s Shale Daily this week.
"There’s been a lot of news flow about reserves-based lending and particularly the redeterminations this fall that are upon us, as it relates to a company's ability to stay afloat and even the...impact on macro trends, like supply," McConn said. Those feared redeterminations have been a bit "overhyped."
In terms of the impacts, "it really only has an impact on a handful of companies. The ones that will really be hampered, the ones whose outlook materially changes, are those companies that probably were already in trouble before the price downturn anyway, and this price decline exacerbated it and pushed them over the edge."
To check the pulse of the domestic exploration and production (E&P) sector, Wood Mackenzie did a deep dive on a group of 26 top independents. What researchers found was encouraging.
"They're in pretty good shape," McConn said. The redeterminations overall are only "a blip on the radar." That's not to say it's a walk in the park. Among the concerns identified by Wood Mackenzie are a lack of hedging on oil and gas production, and that worry is justified, he said.
"The gains for our group in our base case rolls off from about $9 billion in 2015," he said. "In 2016 it reduces by about $2 billion, so there's a lot less protection." How E&Ps deal with price swings "is going to be interesting to watch."
A big question is how much capital spending will be earmarked for 2016 projects.
"We're going to be more focused if companies have low budgets for development plans for 2016," McConn said. "That's something...where we'll get a sense of macro trends for supply, financial health. That's what companies should pay more attention to."
Another question surrounds the fate of dividends. "It's another lever" that E&Ps can play with to help with their spending activity. "This could be interesting where strategies could diverge." Some operators have reduced their dividends. Chesapeake Energy Corp. and Penn Virginia Corp. have scrapped theirs (see Shale Daily,Sept. 17;July 21). "We might see some more major announcements," said McConn.
The peer group that Wood Mackenzie studied is expected to cut its capital expenditures (capex) overall by an average 20-40% in 2016 year/year, on the expectation of a "lower for longer scenario...But the interesting thing about that is, a lot of these companies will be able to maintain flat production profiles” at the lower capex rate. Production rates exiting 2015 probably will remain flat into 2016.
"As far as guidance and budgets go, it's such a dynamic and fluid situation that companies are going to be reluctant to give concrete numbers" regarding spending plans. It's "more likely" that E&Ps will provide only "ranges and indications.
"We think a lot of companies, particularly for the group we're looking at, the floor or bottom part of that range is going to be some kind of budget where it's the amount of money they need to spend to at least keep production flat from the 2015 rate," McConn said.
"Some companies might be in [production] decline in 2016 but as a general goal across the peer group, we think that will be a floor as far as the low price scenario goes. Any pricing upside from there, you may see companies start adding back rigs and activity."
Wood Mackenzie models E&P assets from the ground up and has data on all of the U.S. plays, with breakeven prices to determine how a play works at certain price level.
"It's a big tough to generalize" about where E&Ps will focus their money in 2016, but one key indicator is activity in the Permian Basin "because it is home to a lot of assets and activity." However, some parts of the West Texas/North New Mexico play will work at $50/bbl West Texas Intermediate, some won't.
The Eagle Ford Shale and the Wolfcamp Shale within the Permian are two more "flagship" plays that in general have economics that work at $50. "Those plays are resilient in this environment," said McConn.
The Northeast's Marcellus Shale is another bellwether. "As benchmark prices go, producers are really hampered by infrastructure constraints, the differentials to benchmarks" In the Appalachian Basin. "Getting the infrastructure on stream is going to be a big development as far as unlocking some of the constraints and allowing producers to unleash some more activity."
Where producers have had their biggest E&P successes in the past couple of years "are going to be the most resilient," generally speaking.
Wood Mackenzie also is tracking merger and acquisition activity, but it's not been the story that a few analysts had anticipated. Rumors are rampant, but since the start of the year, most of the domestic E&P deals have been relatively small, mostly bolt-ons.
"As far as big corporate mergers, consolidation would be big news, and for the companies that are very financially strong, have good balance sheets and have the desire to do so, current market valuation says that now could be a pretty good opportunity. Share prices have gotten a bump in the last couple of days, but in general, a lot of companies in this peer group we looked at trade at discounts to our base-case evaluation. The base-case evaluations do assume a long-term price recovery.
"But typically, a lot of companies in this peer group would trade at a premiums to our valuation, which logically could infer that would mean it would deter any big corporate consolidation because those deals would be expensive."
Recent market sentiment has been "a bit pessimistic in oil and gas," which in turn has driven down market valuations.
"Therefore, companies that might have been biding their time waiting for the right opportunity to make a big move now might be the time," McConn said. "I'm not saying that will happen, but it is an opportunity. We wouldn't be surprised."
As far as the E&P sector shrinking and consolidation running rampant, that's unlikely.
"One of the key findings of this report is that most of the producers can stay afloat and all are in relatively good shape for the near term to weather a price downturn. That gives credence to the argument that no, we won't see large-scale consolidation because these companies are able to maintain their businesses as going concerns."