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Happy Days Here Again for Onshore? Almost, Says Raymond James

The outlook for onshore U.S. exploration companies is becoming "incrementally positive" for 2017 and beyond, as supply/demand fundamentals correct and commodity prices begin to move higher, analysts with Raymond James & Associates Inc. are predicting.

John Freeman and Kevin Smith said in a note Monday their expectations for better days ahead for the exploration and production (E&P) sector are based in part on the annual oil and gas conference sponsored by EnerCom, which was held earlier this month in Denver.

Concerns remain, including the overhang on Rockies-based operators that may be impacted by the upcoming Colorado ballot initiatives (see Shale DailyAug. 18a). However, the future of the industry as a whole "looks increasingly bright," said Freeman and Smith. Their sentiments echo those by many other industry prognosticators following more upbeat 2Q2016 results, as well as recent acquisition and divestiture (A&D) activity (see Shale DailyAug. 19).

"The sentiment continues to be that oil supply/demand fundamentals are correcting and it is just a matter of time before oil prices move significantly higher," said the Raymond James analysts. "Rising productivity and improving capital efficiency coupled with an A&D market buzzing with activity is a sure-tell sign of operator optimism regained. In sum, while near-term volatility in oil prices remains unavoidable, we have little doubt that the E&P rally is underway and that the zenith for E&P stock prices remains high."

To date this year, an estimated $20 billion has changed hands for leasehold acreage and mineral interests for U.S. onshore unconventional assets, analysts said. The Permian Basin's Midland and Delaware sub-basins have dominated, with merger and acquisition (M&A) activity of all stripes, including infill acquisitions, step-out transactions and entry deals where operators are laying claim to their first Permian properties.

The main takeaway from conversations at EnerCom is that "we are still in the early stages of an A&D/M&A frenzy in U.S. onshore as companies aggressively try to build a drilling inventory that is economic in a $50/bbl oil price environment," Freeman and Smith said. "While larger plots in the Midland Basin are going to be increasingly difficult to pick up, there are still plenty of Delaware deals to be had. Moreover, there is growing potential for the Eagle Ford Shale to get hot over the next 12 months."

Into the last half of this year, more A&D activity should continue in the Delaware, where a lot of acreage continues to be held by private operators. Outside the Permian, the Bakken Shale and Eagle Ford may get more attention.

"Over the last 12 months the talk around the Bakken was that bid-ask spreads remained too wide. However, the thinking out of conference was the gap has narrowed significantly," with some operators, such as Continental Resources Inc., divesting some of its portfolio (see Shale DailyAug 18b). "As the Midland A&D market dries up, we should start seeing more Bakken transactions, especially as oil prices get closer to $55-60/bbl which would allow for more noncore Bakken properties to achieve the 15% hurdle rate of return."

With natural gas above $2.50/MMBtu and bullish sentiment on natural gas liquids pricing, the Eagle Ford may become more viable for deals as well, with its proximity to Gulf Coast pricing, according to Raymond James.

"In conversations with private operators, we are seeing multiple players looking to funnel capital to the basin as a value play."

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