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'Flat Energy Price World' Less Impactful to U.S. Energy Sector, Says Raymond James

The U.S. natural gas and oil industry should see higher and more sustainable growth over the coming decade as production growth and efficiency improvements create a paradigm shift, Raymond James & Associates Inc. analysts said Monday.

Commodity prices historically have driven exploration and production (E&P) cash flows, but that's changing on technology and efficiency, said J. Marshall Adkins and Praveen Narra.

Huge growth in volumes, with some assist from efficiencies (i.e., lower costs) "has set up a future where the U.S. oil and gas industry can post solid, profitable growth in a flat energy price world," wrote the duo. "In fact, we now expect the U.S. E&P industry (as a whole) to be cash flow positive through 2016."

Traditionally, domestic E&Ps have outspent cash flow, with the only governor on spending usually what's available in the till, plus debt or equity infusions. When capital expenditures (capex) outpace cash generation, however, the returns usually aren't positive.

"We now think this 50-year U.S. energy paradigm is about to change...driven by the increased horizontal well efficiencies," which could lead to more sustainable improvements over the coming decade. Raymond James team said cash flow generation could outpace capex "even in the declining oil and gas price scenario predicted by today's futures prices."

The changes also should lead to growth for U.S. oilfield service companies, said analysts. Raymond James analysts developed a revised total U.S. E&P cash flow and spending model with basic year/year (y/y) changes in production, pricing corrected for natural gas liquids (NGL) output on and offshore; basis differentials; hedging; operating cost changes; and changes in land acquisition capital spend. Analysts used Spear & Associates to aggregate drilling and completion capex, which provides an overall cash flow/capex picture different from current consensus views.

Assuming strip pricing, total 2014 U.S. E&P cash flow growth "should be up a whopping 30% y/y," said Adkins. The logic is based on blended oil and gas volumes up 9% (oil/NGL up 15%, gas up 6%); commodity pricing is up 10% (oil/NGL prices up 2%, gas 25%), and costs/boe are down slightly.

"These factors all result in the expected surge in 2014 E&P cash flows. Even though we are factoring in the 'backwardated' oil and gas futures price strips, it is important to note that rising supply growth should still drive strong U.S. E&P cash flow growth going forward."

The modeling, which also benefits oilfield services companies, would appear to suggest that the U.S. energy sector "is no longer fundamentally driven solely by the commodity cycle but is beginning to resemble more of a manufacturing space," said Adkins.

Analysts don't assume domestic operators are immune from price swings. "Instead, we are saying that U.S. E&P cash flow and profitability can now actually increase in flat to modestly declining energy price environment."

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