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Midcontinent Energy Activity Considerably Better in 2Q, Outlook Turns Positive, Says Fed

Oil and natural gas activity across the Midcontinent "improved considerably" during the second quarter, and the outlook for future activity has turned positive for the first time this year, the Federal Reserve Bank of Kansas City said Friday.

The quarterly energy survey for the Tenth District encompasses responses from firms working in the western third of Missouri, the northern half of New Mexico and in Kansas, Colorado, Nebraska, Oklahoma and Wyoming.

"Energy activity improved considerably this quarter and expectations were positive," mostly because of recent price gains, said economist Chad Wilkerson of the Oklahoma City branch. "Still, firms indicated prices need to be approximately $64/bbl to see any substantial increase in drilling activity."

On average, companies surveyed are predicting West Texas Intermediate (WTI) prices will be $53/bbl by year-end 2016 and $62 by year-end 2017. Prices on average need to be $64/bbl to increase drilling "substantially," respondents said. And companies don't expect to boost hiring only because of the recent recovery in oil prices.

The expected oil prices index increased to 58, which means more firms see higher prices in the future. The outlook for natural gas and natural gas price indexes also increased at a "strong pace."

Asked what they expected the WTI price to be by year-end 2016, those surveyed forecast an average price of $53/bbl, up from $45 in 1Q2016 and $50 in 4Q2015. Companies surveyed projected an average price of $62/bbl by year-end 2017 from $56 forecast in 1Q2016 and $60 in 4Q2015.

To sharply increase drilling, companies said they would need an average $64/bbl oil price, versus an estimate of $60 in 4Q2015. For natural gas drilling to be higher, firms said they would need an average price of $3.65/MMBtu.

Overall, energy activity was flat across the district between April and June, based on the survey, which was conducted from June 15-30. However, the drilling and business activity index increased from minus 72 to 0, "suggesting that activity was no longer significantly declining."

When asked their views on the recent recovery in oil prices, several of the companies surveyed pointed to the unexpected global production outages in Canada, Nigeria and Libya, along with improved global demand data as factors. "Others noted that U.S. shale production was falling faster than expected."

The total revenues index for the region increased moderately between April and June, but it remained negative at minus 31. The employment index increased slightly, while the employee hours index remained mostly flat. The wages and benefits index also edged higher, and access to credit continued to improve.

"Expectations were significantly more optimistic this quarter," the survey found. "The future drilling and business activity index jumped from minus 31 to 39, the first positive reading in a year. The future revenues index also turned positive."

While energy activity in the Midcontinent from a year ago improved somewhat, it remained at a negative level at the end of June. The drilling and business activity index rose, but remained at minus 65, and revenues/profits also edged higher. Employment and employee hours indexes moved up slightly, as did wages and benefits. Access to credit inched up from the first three months of this year. However, the capital expenditures index fell back to the low seen in 3Q2015.

Expectations for future employees and hours has improved, as has the outlook for wages and benefits. The future access to credit index climbed from minus 35 to 0. Meanwhile, the future capital spending index climbed to 17, "the first positive reading since 2014," the Fed said.

Asked if hiring plans had changed because the uptick in oil prices, most respondents said they don't plan to make any changes to employment levels. However, "some respondents noted that they were filling a couple of important vacancies from a large pool of top talent."

Firms also were asked how they expected the recent rally in oil prices to impact their financing, with the majority expecting "no changes or a decrease in credit. Several respondents commented that prices needed to be higher for a sustained period of time to see changes in credit availability. Banks and financial markets were expected to remain cautious."

Regarding the outlook for mergers and acquisitions (M&A), as well as defaults and bankruptcies in the second half of 2016, about one-third forecast "large increases in M&A but little change in defaults/bankruptcies," while another one-third expect "little change" in M&A but a big increase in defaults/bankruptcies.

"Some firms said that prices have been low for too long and therefore, highly leveraged companies would continue to default in the coming months. Others surveyed said the recent price recovery would lead to some asset buying and acquisitions from better-positioned companies.”

One executive surveyed said the market "is priced correctly, with some limited increase in prices over the next couple years. Ultimately, there is plenty of supply and the real question is foreign economic growth and the demand for oil. The demand issue is a much longer, harder issue to solve in the oil market."

Another said commodity prices would continue to drive business activity. "We plan to keep cash flow neutral and mend the balance sheet as price recovery occurs with cautious approach to acceleration of activity."

The lack of financial wherewithal across the industry was not lost on one executive who was surveyed. "Many producers are so upside down they can't sell, even though there is a lot of money available. This will lead to more bankruptcies and restructurings. After that we will see mergers and acquisitions pick up."

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