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U.S. E&P Capex Down 60% from 2014, Operators Also Less Hedged

Spending by U.S. producers is estimated to be down around 60% from 2014 -- twice as much as some analysts have estimated, Raymond James & Associates Inc. said Monday. North American producers also have less protection from sustained low commodity prices than they did a year ago because of less hedging, according to Barclays Capital.

In two separate notes issued on Monday, Barclays looked at North American natural gas producers and hedging practices. Raymond James & Associates Inc. focused on the domestic oil operators' hedging going into 2016, and extrapolated capital expenditure (capex) forecasts.

"Hedges for 2015 have helped producers weather a low price environment where gas prices have averaged just $2.85/MMBtu," wrote Barclays analysts Nicholas Potter and Michael Cohen. "However, with hedges rolling off and prices expected to remain under pressure in 2016, producers will be less protected from sustained low prices compared to this year."

Exploration and production (E&P) companies are volumetrically under-hedged for 2016 gas output versus where they stood in 2014, according to the Barclays duo. "We think this points to producers feeling that natural gas prices have largely bottomed and that hedging at current levels could potentially lock in losses."

In Barclays’ peer group of 43 large and mid-cap producers across the United States and Canada, only 11% of 2016 gas output had been protected through hedges, below the 22% level seen at this time last year for prompt year (T+1) hedging.

"Of the total peer group, 22 of the 43 companies have not put in place any hedges for 2016," wrote Potter and Cohen. "In 2015 volume terms, the large-cap producers account for around 88% of production of the 43 company peer group...and these companies account for around 27% of North American production." Gas hedges for 2015 stand at 38%, "below the 52% level seen at this time last year for T-0 (2014)."

This year's gas hedges have played a significant role in allowing E&Ps to maintain output growth even on weakened prices. Hedge protections also may have led to more output in an already long market, "setting the stage for a potentially difficult 2016."

The mid and smaller cap gas producers "have been more inclined to hedge their 2016 production in an attempt to cover their costs and get a return, possibly allaying some fears lenders may have. In dissecting the hedge data from our peer group, we can see a bifurcation between producer types. The 21 large cap producers have hedged around 7% of their natural gas production in 2016. This compares to the 22 mid-cap producers in our peer group, which have hedged a total of 46% of their 2016 natural gas production volumes."

Data suggests that the mid caps have hedged 2016 volumes at an average $3.99/MMBtu price, which means hedges were entered into in early 2014, said Barclays analysts surmised. This compares to an average 2016 hedge by large-cap players of $3.47/MMBtu.

As to when there might be a recovery for the U.S. E&Ps, Raymond James analysts don't see one before 2017. Even if there's a modest recovery in oil prices next year, cash flow probably is going to be flat from 2015 also because of oil hedges rolling off, said Praveen Narra, J. Marshall Adkins, Graham Price and John Woodiel.

"While it's still far away, 2017 appears to be setting up for a significant recovery year with U.S. E&P cash flows up 50% and spending up over 60%, assuming an only modest $10/bbl improvement in oil prices," the Raymond James analysts wrote.

It could be better -- or it could be worse, said the Raymond James analysts. For example, a $5.00/bbl change in West Texas Intermediate would lead to a 20%-plus increase (or decrease) in U.S. cash flows and spending levels.

"That sword is sharp and cuts both ways...Relative to our $55 oil price deck for next year, a $50 price means U.S. cash flows would be about 20% lower than our current model, while a $60 price would give a robust 20% increase in U.S. E&P cash flows."

Domestic explorers tend to reinvest their cash flow on drilling, which means that the U.S. oilfield service activity outlook is keyed to forecasting E&P cash flows. Instead of conducting a rear view mirror survey of E&P spend, Raymond James analysts used a top-down cash flow model to look at the United States "as one singular E&P company."

Using their price assumptions, Raymond James analysts determined that this year's cash flows are going to plunge about 60% from 2014. Next year, capex appears to be fairly flat with 2015. By 2017, however, E&P cash flows should be up a "whopping 50% over 2016," according to Raymond James.

"While most highly publicized E&P spending surveys were forecasting a 25-35% reduction in 2015 U.S. capex, our math says that U.S. spending will be down a much larger 53% in 2015," said the four analyst. "So what happens for the rest of 2015? Since U.S. E&Ps have already cut rig counts and largely adjusted to the lower price environment, we expect the 4Q2015 U.S. rig count will be roughly flat (with a modest upside bias) through the end of 2015..."

Even if oil prices average $5.00/bbl more in 2016 per the Raymond James model, hedging differentials should reduce the realized oil price for next year by about 8%, or $4.50/bbl.

"U.S. E&Ps were 'fortunate' that for 2015 many of them had locked in volumes at prices that were more similar to 2014 levels," analysts noted. "We estimate that 20% of the industry's production was hedged at closer to 2014’s price levels of $90-plus. With 2016 volumes significantly less hedged, the roll-off in hedging results in a 10-15% hit to cash flows."

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