The upstream oil and gas industry, which has managed to stay afloat this year through mergers, debt and derivatives, is poised to hit even choppier seas in 2016 as acquisition activity slows and leveraged companies face increased probabilities for defaulting, according to a cadre of energy experts.

BDO USA’s Clark Sackschewsky, a partner with the Natural Resources practice, discussed trends that the sector can expect to see in the coming year. Other energy teams also are weighing in, but none are offering any positive scenarios.

“Everyone’s got a different opinion about how long the downturn is going to last,” Sackschewsky told NGI’s Shale Daily. “If you are looking at what’s happening globally, the expectation is 12-18 months for recovery. And it’s not going to be a significant recovery, not back to $80s oil prices anytime soon. But getting back up into the $60s makes everyone feel a little bit better, and we’ve got to get out of the $40 range.”

As to when prices could begin to recover, “there’s lots of different theories about that, such as the Saudis having to pay back the bonds they issued. They are going to need to get prices back up. Some of the other OPEC nations like Venezuela, Russia, need prices to go up a little bit in order to fund their social policies that they have in place.

“You’ve got the pessimists who think it’s going to be two to three years for a recovery, but that’s not realistic. I think there’s going to be enough frothiness that prices are going to go up. We’re seeing the cutbacks in the spending and that will reduce supply. But there’s no quick recovery whatsoever.”

Most exploration and production (E&P) companies, as well as oilfield services (OFS) operators, during 3Q2015 conference calls declined to offer much guidance about capital expenditure (capex) plans for 2016. That posits the theory that capex is going to fall, and with it, production. And that means the OFS sector still has further to fall.

“That’s the billion dollar question,” Sackschewsky said of the OFS vendors. “It’s going to be a tough ride for them. It goes back to the companies that jumped on cost cutting internally, the ones that had strong balance sheets, they’re going to survive. The other ones that took on a little bit of debt, that took on additional assets for drilling purposes hoping that things would continue on the way they had been, they’re going to be hurting. What’s going to happen is, there’s going to be a huge fire sale going on.”

He said to look no further than Canada, which has seen its oil and gas activity almost come to standstill to understand the pain that’s ahead for the OFS sector.

“It’s going to slow down, slow down, slow down as production and drilling slow down,” he said. “Only the strong are going to survive.”

Fitch Ratings credit analysts Dino Kritikos, Mark C. Sadeghian said more E&P cutbacks are expected in 2016, which would add pressure to OFS metrics next year. They said capex cuts for

“U.S. independents will be the deepest and could be reduced an additional 20-30% following an average 35% cut in 2015.”

Rystad Energy’s Per Magnus Nysveen, head of analysis, and colleague Leslie Wei compiled their outlook for expected 2016 trends in North American shale. In an update issued in August, Rystad said North American capital spending had fallen by 45% to a total of $95 billion while production had increased by 13%, 15 million boe/d, over 2014 levels.

“In 2016, shale operators are expected to continue activity at current levels, which is sufficient for a slight increase in production year over year,” the Rystad analysts said. “The high grading of acreage helps boost production while activity remains low.”

Rystad foresees total production in North America increasing by 4% year/year while capex drops another 9%. Shale plays dominating the most attention are expected to be the Permian Basin’s Delaware sub-basin, as well as the Woodford and Utica shales.

Capex-wise, the Permian’s Delaware is seen leading the way in 2016, up 10% year/year, while the Bakken and Eagle Ford shales, as well as the Permian’s Midland sub-basin, should see a 10% decline in spending from this year.

“A combination of high grading, efficiency gains and a decrease in unit costs allows production to continue to increase while costs decrease,” Nysveen said. “During the first nine months of 2015, there was an observed decrease of 20% per barrel. This trend is expected to continue into 2016, partly because the benefits from lower service costs will be realized for the full year.”

Wunderlich Securities Inc.’s Jason Wangler and Irene Haas said it would be “easy” to say 3Q2015 results weren’t much fun as the reduction in energy prices brought not only the reported numbers down but also caused almost every E&P and OFS name to hunker down going forward. They expect little to zero onshore drilling activity from Thanksgiving through the rest of the year, echoing recent comments made by Fairmount Santrol CEO Jenniffer Decker during a quarterly conference call (see Shale Daily, Nov. 13).

“Following a month-long vacation for E&Ps and the OFS players, we think that 2016 will start slow with a January hangover effect as E&Ps remain careful and guarded with their spending plans,” the Wunderlich analysts said. “This might result in more serious U.S. production declines that the market has been waiting to see, and could possibly allow the U.S. to begin working off its significant inventory of oil and natural gas.”

Commodity price improvements “will likely favor the E&Ps first and the OFS second. While we are not expecting prices to recover overnight by any means, we think that when oil and natural gas prices begin to move higher, most E&Ps will use the additional funds to repair their balance sheets rather than add activity. This lag will likely cause the oversupply in the OFS space to continue even as commodity prices improve.”

Management teams for some of the majors have indicated this year that they are concerned that cuts to capex may undermine growing reserves. But Sackschewsky said onshore unconventional projects have changed the way reserves are built.

“I think the world has changed from deep sea drilling,” he said. Deepwater projects do provide huge amounts of reserves, but they take years of appraisal and exploration drilling before any wells are tied to sales. Unconventional drillers, meanwhile, can “drill seven days a week, seven different holes and the risk associated with that is a lot less than trying to find that one big pot of oil sitting underneath pre-salt in Brazil.

“It is correct that we need investment or otherwise we’re going to be in trouble. But the level of trouble that we may be in can be quickly overcome just because of the size, cost and the quickness that you can drill in North America and other shale plays around the world is so much faster. I think we can ramp up quick enough to meet the market need. Now you can be in production in 30 days, not three years, from the time you spud until you at market.”

The energy sector has lost tens of thousands of employees this year. However, the impact long-term may not be as dire as some expect. Companies are downsizing “a little bit smarter now,” Sackschewsky said.

“They remember what happened in the early 2000s where there were mass layoffs. All of the sudden we had a huge generational gap of knowledge that once production starting getting back up in 2005, 2006, they realized, ‘Holy crap. We haven’t hired in 30 years. There’s nobody out there that knows this stuff.’ And the people that did know were getting ready to retire.”

Many management teams realized they made mistakes in the last round of mass layoffs. “They are being very strategic not to lay off large groups,” Sackschewsky said. “They’re going to try and keep their personnel as long as possible, but they’re looking at the engineers, the geologists…the key personnel that they need. They need their engineers; they need geologists, and they need them at all levels.

“Instead of laying off necessary positions, companies instead are going to stack assets and rigs and lay off those crews.”

Once the market begins its upturn, many of those laid off will return, he said. “At the end of the day, if you tell somebody you can make $50,000 as a mechanic or you can come out to the oilfield and make $100,000, then when things start ramping back up, at that level people will start coming back.”