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North America's Upstream Costs Offer 'Silver Lining,’ Says Wood Mackenzie

An unprecedented level of uncertainty exists for North America's upstream sector this year, but upside exists for operators to trim service costs, high grade their portfolios and improve efficiencies, according to Wood Mackenzie Ltd.

"We are already seeing this play out as upstream operators announce drastically reduced capital budgets for 2015, yet forecast increased production growth (in aggregate)," said the firm’s Delia Morris, senior North American upstream analyst. "As long as operators can move to the core areas of plays and sub-play breakevens continue to fall with the drop in service costs, producers will keep chugging along until funding dries up."

Analysts identified several key themes this year for the domestic upstream sector. They also offered their take on the outlook for North American liquefied natural gas (LNG) and natural gas liquids markets.

Upstream costs may be the "silver lining for operators," they said. "As companies have decreased capital budgets, we are seeing a slowdown in drilling activity. This reversal is already having an impact on the demand for rigs, pressure pumping fleets and other key equipment and services. If the oil price were to average around $50/bblin 2015, we anticipate a 40% decline in the horizontal rig count compared to 2014. Rig day rates could fall by 30% or more."

The forecast mirrors predictions by many analyst firms that are predicting a drop in U.S. capital spending of at least 30%. Exploration and production (E&P) firms also are expected to see upside from refracturing wells, where the technique is surpassing production rates from initial fractures (fracks). Refracking may provide a boon to several now neglected gas-rich plays.

"Over the past year, lower U.S. natural gas prices drove Marcellus operators to shift attention to horizontal refracks in order to increase recovery rates at reduced costs (25% lower expenses for a standard well). Successful refrack testing also took hold in gas-rich plays like the Haynesville and Barnett, where some operators were able to reset production rates to early life profiles and, in some cases, increase performance."

Another gas priority for E&Ps this year may be the Haynesville Shale, where "dry gas is back," the analysts said. "Crude market realities will drive service costs down in 2015, and this improves the return of dry gas investment, which will be competing for capital in an environment with fewer economically attractive options." According to Wood Mackenzie's latest Haynesville key play update, breakeven costs for several sub-plays look strong, particularly for the Greenwood-Waskom ($3.46/Mcf), Spider ($3.31) and Woodardville ($3.37).

Meanwhile, North American LNG has lost some of its "luster," but it should maintain its momentum.

"We expect that only six U.S. projects with total capacity of around 60 mmty [million metric tons/year] will be under construction in 2015," said the Wood Mackenzie team. "Four are already being built (Sabine Pass LNG, Cameron LNG, Freeport LNG and Cove Point LNG), while two other facilities (Corpus Christi and Elba Island) will begin construction in 2015. We also anticipate a final investment decision at Canada's Pacific North West LNG in 2015, in tandem with further upstream investments in the Montney."

Less positive for gas markets is the domestic ethane business, which has become "chronically oversupplied," now requiring "maximum rejection, fuel demand to replace natural gas, and exports to balance." Several gas pipelines have maxed out their BTU limits "as ethane is kept in the gas stream since it is more valuable as a fuel than as a chemical feedstock. We expect ethane to continue to trade at a 50 cent to $1.00/MMBtu discount to natural gas for the foreseeable future."

Also on the radar for Wood Mackenzie are spot ethylene margins, which are seen remaining under pressure this year as supply outstrips demand. This year producer margins are seen shifting from the ethylene cracker back to the polyethylene unit, with polypropylene margins improving.

"The biggest factor to watch during 2015 is how the industry runs its plants; can they finally overcome all of the unplanned outages and run at reasonable rates? If not, the U.S. petrochemical industry could continue to experience a supply constrained market for a fourth year in a row."

For the Gulf of Mexico (GOM), expectations are for U.S. activity to defy low oil prices, with activity up by more than 30% from 2014 on a ramp-up in development drilling and rig contracting. Operators also would be fighting the clock on lease expirations, said analysts.

For Mexico, lower oil prices could mean less activity, except for the big players. "Overall, interest will likely focus on discovered fields rather than exploratory blocks, with the exception of Perdido," in Mexico's deepwater GOM. Reduced interest also is seen in natural gas, unconventionals and heavy oil blocks, all on the lower price environment.

For U.S. onshore oil plays, the Eagle Ford Shale "remains the cream of the crop." Permian Basin merger and acquisition activity also is seen heating up in the second half of the year.

A sharp drop-off in activity is seen in Western Canada, but to a lesser extent in liquids-rich areas that include the Duverney, Montney, Falher/Wilrich and Glauconite. "The expanding commerciality of intervals in the Deep Basin and drilling in newer niche plays like the Torquay in Saskatchewan will continue, but at a reduced pace."

Canada's oilsands won't be as fortunate, according to Wood Mackenzie, with as many as 16 projects at risk of being deferred if low oil prices persist. In addition, Keystone "chances look dim for the approval of the pipeline in 2015 via legislation."

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