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E&Ps Working to Survive Rather Than Thrive, Says Barclays

Producers have shifted from growth to survival mode, applying technology to overcome the constraints of diminished revenue expectations, according to Barclays Capital. The investment firm held its annual energy conference last week, which featured presentations by exploration and production (E&P) companies.

Producers have yet to issue formal capital expenditure (capex) guidance for 2016, but a major theme at the conference, consistent with 2Q2015 earnings calls, was a call to live within cash flow, said analyst Michael Cohen. He and his colleagues recapped the conference in a note.

Capex levels overall are expected to be down by about 20% year/year in 2016, as cash flows decline because of lower prices, according to Barclays. For 2016, the firm reduced its oil price deck to $55.00/bbl West Texas Intermediate from $65.00, with natural gas prices now expected to average $2.95/MMBtu from $3.25.

"Despite lower capex levels, most producers are sticking with the story that cost reductions, efficiency gains and high grading will allow them to maintain either flat or even growing production next year in a low price environment," Cohen said. Most E&Ps have taken steps to shore up their balance sheets, but more activity "is likely" if prices remain suppressed.

"Producers have focused on core holdings and parted with less suitable assets in their portfolios," he noted. "Cash generated from asset sales have been used to pay down debt and provide for production growth when prices do get more attractive.

"Furthermore, companies expressed the view that it made little sense to borrow money or issue equity at current prices, particularly to grow production."

Most E&Ps have come to terms that prices won't budge much in 2016, and many are using the current calendar year 2016 strip for planning purposes, analysts said. "Generally speaking, most producers find it difficult to rationalize (outside of covenant requirements) hedging 2016 production at current price levels, particularly for oil."

Exceptions are some of the big Marcellus Shale operators, including Range Resources Corp. and Antero Resources Corp.

"Range currently has more than 50% of its 2016 gas production hedged at a floor of $3.42, while Antero is 97% hedged," said Cohen. Cabot Oil and Gas Corp. "said it sees current pricing on forward differentials as 'punitive' and will restrain from hedging as it does not think prices can get much worse..."

The three-day conference also affirmed that E&Ps still are hunting for lower costs and even more efficiencies in their well designs.

When questioned about the sustainability of the cost reductions, some E&Ps, including Encana Corp., "suggested that two-thirds of the gains made in the first half of 2015 will be sustainable in a higher price environment."

Experiments continue to focus on increasing well lengths and fracture stages, and using different well materials.

E&P executives highlighted the infrastructure projects in the onshore, with many seeing a glut of natural gas midstream takeaway, with lengthy take-or-pay midstream contracts now considered burdensome, said Cohen.

"As Marcellus plays wait for new infrastructure to get their volumes to higher-priced markets, there seemed to be a view within the conference that there could be a glut of midstream infrastructure in the coming years," he said. "Given how quickly basis markets have been changing, companies seem to be increasingly hesitant to take on firm pipeline capacity for natural gas."

Basis differentials also are diverging for oil and gas, executives said. Oil differentials should continue to improve as pipeline takeaway capacity expands and production either grows (i.e., in the Permian Basin) or declines (i.e., in the Bakken and Eagle Ford shales and in the Niobrara formation).

However, for gas, negative differentials continue to be a "major issue in the Northeast," with executives from Cabot, Antero and Range each indicating they have been receiving a minus 95 cents-$1.50/MMBtu differential to New York Mercantile Exchange pricing.

Meanwhile, contrary to predictions, merger and acquisition activity should remain sluggish.

"Company-level buyouts or mergers among producers were seen as less likely because potential targets either had unattractive assets or impaired balance sheets," said Cohen. "Some producers alluded to the potential for more asset sales/swaps, a trend that took hold during the latter half of 2014 and first half of 2015."

As E&Ps tighten their belts, expect a focus on the core assets, with noncore asset sales likely to continue, he said.

Questions remain for 2016. Barclays analysts questioned how sensitive the drilled but uncompleted wells, or DUCs, would be to rising prices. They also wondered whether price stability was necessary for strategic completions to occur.

"Will leaning on DUCs in 2016 set us up for an undersupplied market in 2017?" asked Cohen. "Given the way 2016 capex budgets look currently, where will well backlogs stand at year-end if companies are capital-constrained to drill new wells?"

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