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U.S. Onshore Still Consolidating as Prices Stagnant, Efficiencies Mount, OPEC Lurks

The opportunities for U.S. onshore explorers and the oilfield service sector are becoming more concentrated as efficiencies continue to improve, more projects start up and the potential for rising overseas capacity awaits, reducing the call on unconventional supply growth beyond 2018, according to analysts.

Scale among exploration and production (E&P) companies remains "critical" to thriving in a stagnant $50/bbl West Texas Intermediate (WTI) price world, and that means more consolidation, said Goldman Sachs analyst Brian Singer.

Dealmaking has been strong for months. On Tuesday alone Lonestar Resources Inc. agreed to pay $116.6 million to boost its holdings in the Eagle Ford Shale of South Texas, while Denbury Resources Inc. paid $71.5 million to increase its Wyoming holdings.

Helmerich & Payne Inc. last week agreed to buy directional drilling technology expert Motive Drilling Technologies Inc. Keane Group Inc. in mid-May built its onshore offerings in a deal to acquire RockPile Energy Services LLC.

U.S. unconventional activity began to ramp up aggressively last year following a decision by the Organization of the Petroleum Exporting Countries (OPEC) to temporarily pull back. However, OPEC members agreed last week to extend their production cuts through next March, at some point, full capacity will return.

"We are now in year seven of shale's material impact on global oil supply-demand," Singer said. "In 2012-2014, shale dominated growth, with prices high partly due to OPEC disruptions," said Singer. "In 2015-2016, OPEC dominated growth, with low prices forcing shale into decline. In 2017, shale is dominating growth again, aided in part by OPEC's willingness to cut production."

Meanwhile, the U.S. land rig count has more than doubled since May 2016, and while it could rise further, it may be nearing a plateau, according to Goldman.

"First, owing to well productivity (partly on greater pressure pumping and sand intensity), we believe a rig count in the 850-900 level is enough to grow U.S. oil production by 800,000 b/d annually," Singer said.

Also, E&Ps cannot justify continued growth in the U.S. land rig count given limited free cash flow generation. As well, short-term bottlenecks are developing based on the timing of planned pressure pumping capacity additions, which could push higher the inventory of drilled but uncompleted wells, or DUCs.

"As a result, we expect demand for completion services to continue to grow despite flattening in the rig count," Singer said.

Going forward, there's room for combined oil growth in 2017-2020 by OPEC/shale operators of 1.0-1.3 million b/d per year. "How this growth is rationed will be key to both absolute oil prices and oil price volatility," he said.

U.S. E&Ps that are negatively impacted by a $50/bbl average oil price may need to depend on hedging or risk broadly outspending cash flow. A price signal may be needed to stop shale activity acceleration further. U.S. oil production is forecast to grow by about 800,000 b/d per year in 2018-2020, versus 1.0 million on average in 2013-2015. The forecast assumes, however, that OPEC "is more restrained versus its growing capacity," said Singer.

To achieve "rational" growth from both OPEC and unconventional operators, the oil futures curve needs to move to backwardation to limit aggressive U.S. producer hedging, he said.

Goldman is maintaining its long-term oil price of $50/bbl WTI. The forward curve may need to reflect an oil price at/below $50 until there is more confidence in "normalized" inventories.

OPEC's willingness to extend cooperation is "incrementally bullish, and oil prices have more room to recover," according to Raymond James & Associates Inc. Analysts led by J. Marshall Adkins said Tuesday they share investor frustration that the original OPEC agreement didn't sustain oil prices above $50.

"The extension, all else being equal, should provide a 1.1 million b/d average benefit (versus our pre-extension oil model) from 3Q2017 to 1Q2018, and this is a big deal," Adkins said. Ultimately, "fundamentals are what matter." And fundamentally, global oil inventories are on track to drop below a normal level of 30.5 days of supply during 3Q2017.

"Bearing this in mind, the current oil futures curve for the second half of 2017 and 2018 looks much too low, and we remain of the view that prices will be recovering further to reach cyclical highs over the next six to nine months," Adkins said.   

Coker Palmer Institutional (CPI) on Tuesday lowered its oil price deck and pushed the recovery in prices to 2019.

"Crude oil prices are struggling with the 'twin caps' of the eventual ending of OPEC plus others' 1.8 million b/d cuts and strong (1 million b/d) U.S. shale growth," CPI analysts said. "Thus, we lower our oil prices to $50/bbl for both 2017 and 2018." By 4Q2018, prices are expected to average in the mid-$50s, with a 2019 average of $60/bbl.

Meanwhile, CPI raised its near-term natural gas price deck for 2017 because of reduced supply and "strong demand," which have offset higher-than-normal inventory. Longer-term, analysts are sticking with a $3.00/Mcf forecast. "If we can make the investment case for gas equities at $3.00/Mcf, then any lift to $3.25-3.50 is 'gravy,'" analysts said.

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