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E&Ps Expected to Spend Close to Cash Flow in 2016, 'Growth Be Damned'

Third quarter results for exploration companies are about to begin, with the oilfield services sector kicking things off this week and next, and interest is especially keen on what the spending plans are for 2016. Consensus by three analyst groups is a double-digit decline from 2015 levels, with spending well below the halcyon days before the oil crash.

It's not so much what the third quarter reports could mean for any one company but what 2016 could mean in terms of living with a lower-for-longer oil price, according to BMO Capital Markets. Analysts Phillip Jungwirth and Dan McSpirit said it's the time of year when producers "begin painting the picture for the new year."

Conversations with many management teams over the past several weeks "tells us that spending closer to cash flow will be a game plan presented by most companies, growth be damned."

BMO is basing its aggregated estimates by analyzing 45 U.S. E&Ps it covers. In general, capex should decline 24% year/year (y/y) in 2016 versus a 34% decline in 2015 from 2014. A "modest" 8% recovery is expected in 2017 capex levels, with 12% more spending in 2018.

There's "no ignoring that such estimates point to the potential of a tighter supply-demand balance, forgetting global and exogenous events that could decide otherwise," said Jungwirth and McSpirit. "We continue to lean on the 'defensive quality' thesis where the common denominator is a strong balance sheet, whether rooted in rock quality or a strong hedge book or both."

Wells Fargo Securities analysts are maintaining a cautious stance for 2016. Analysts led by David Tameron and Gordon Douthat expect full-year 2016 capex to decline y/y. Based on $50/bbl crude and $3.00/Mcf natural gas, 2016 capex excluding acquisitions/divestitures is modeled at 17.3% below 2015 levels, or down $9.4 billion from 2015. In general, large cap E&P spending is expected to drop by almost 20% y/y, while small cap spending would fall by close to 27%.                                                

"While marginally lower versus 2015, we note 2016 capex would be down 49.6%, or $44.0 billion, from 2014 levels," said Tameron and Douthat.

During the upcoming quarterly conference calls to discuss 3Q2015, Wells Fargo analysts are anticipating "more of the same commentary we got with 2Q2015 results regarding efficiency gains, service costs, and a focus on liquidity, balance sheets and spending levels." A bit of clarity may be provided on 2016, "but on the whole we expect companies to defer providing guidance until January/February."

A theme of doing "more with less" is expected, "but if $50/bbl plays out, growth expectations need to come down. Perhaps it will take a few bellwether companies to signal that growth at $50/bbl isn't achievable to give others a pass and for the Street numbers to adjust to this reality."

The worst case scenario for the group, said the Wells Fargo duo, "is if prices rise meaningfully between now and February. Under this scenario, companies would increase hedging positions and distort the price signals being sent by the market -- another case of micro good, macro bad. If management teams base 2016 guidance on an elevated, but unsustainable strip pricing, consensus production estimates rise in tandem, the U.S. supply-demand outlook does not improve, and we have calendar year 2015 on replay to start the first half of 2016."

Tudor, Pickering, Holt & Co. (TPH) offered a global capex outlook, which includes integrated and large-cap E&Ps in the forecast. Overall capex in 2016 could be down by half from peak levels in 2013 to a total of $25 billion, said analyst Anish Kapadia. The lower capex is attributed in part to lower oilfield service costs, but "many E&Ps are virtually abandoning exploration altogether, especially in the U.S. where companies are focusing on their unconventional portfolios." The analyst cited as examples No. 1 independent ConocoPhillips, Marathon Oil Corp. and Murphy Oil Corp.

Offshore spending also appears to be headed sharply lower, considering, among other things, last month's Western Area Gulf of Mexico Lease Sale 246, where the "value of bids was down 80% y/y, with only 13% attracting bids" (see Daily GPIAug. 19).

Overall, however, the sharp reduction in E&P spending "can only be positive for oil prices over the long-term," Kapadia said. "There is not enough existing discovered resource and U.S. shale to sustainably grow production over the next decade and it takes five years in the best case and generally closer to 10 years to take a major conventional discovery into production."

Some of the operators with deeper pockets likely will be looking for opportunities to buy more assets in the low-cost environment. One area being eyed is the Permian Basin, Kapadia said. ExxonMobil Corp. and BP plc are among those expected to be acquisitive.

"Is it cheaper to buy discovered resource than explore for it?" Kapadia said. "We believe that certainly for the majority of companies it is more economic in this market to acquire discovered resource than explore for it. Another argument against exploration is that you can buy discovered resource cheaper, which is apparent when you see many companies trading at very low cost/bbl valuations."

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