U.S. upstream operators appear cautiously optimistic about 2019, as Lower 48 natural gas makes its way overseas and new Permian Basin infrastructure reduces constraints, but the mantra of returns over growth may continue, according to energy industry prognosticators.

Bellwether Schlumberger Ltd., the No. 1 global oilfield services (OFS) operator, issued its 4Q2018 results Friday, setting the tone for the earnings season and outlook for the year. First out of the gate was Kinder Morgan Inc., which issued its results on Wednesday.

Schlumberger’s earnings report will be followed next Tuesday by Halliburton Co., the second largest global OFS and No. 1 pressure pumping company in North America.

Just Released: NGI's U.S. LNG Tracker -- volumes of gas delivered to the 6 operating LNG facilities -- updated daily

Evercore ISI’s James West, who follows the OFS sector, said on Wednesday caution would be the watchword after oil prices took a sharp turn downward toward the end of the year. That followed reduced completion activity, takeaway constraints in the Permian and “budget exhaustion” in the exploration and production (E&P) sector during the second half of 2018.

Evercore is turning bullish, as it expects oil prices to move higher, while “poor U.S. land fundamentals” begin to fade in the second half of 2019. In addition, “the international upturn is upon us and will be significant in the second half, and the offshore cycle is moving more rapidly higher.”

The OFS operators overall have maintained high investment levels even when prices slumped to gain competitive advantages and chase market share. If prices do move higher as expected, the sector should reap the benefits.

Global upstream capital expenditures (capex) mostly have recovered from the downturn, setting the stage for “a more synchronized global recovery for E&P spending in mid-2019,” West said. “While it is likely to start later than usual in North America, with operators slow to set budgets given the commodity volatility, it seems like oil prices have bottomed and sentiment should start to improve.”

Another positive is the global liquefied natural gas (LNG) market, where the upcycle is underway. With an estimated $120 billion in final investment decisions over the next few years, “investors are slowly waking to an emerging trend that stands to change the current world order and provide top-line and earnings growth to a few companies nested in the LNG supply-chain,” West said.

Nearly every day offers a “positive anecdote for this trend,” West said, “whether it is in the form of a new LNG export terminal receiving approval or coming online or an announcement from a national oil company or country that expresses its desire to further entrench itself as an energy player.”

Offshore Capex Improving

For Rystad Energy’s team, it won’t be all about shale and tight plays this year. Analysts expect the offshore OFS sector to outpace the onshore.

“At current oil price levels, spending on land rigs, fracturing and other services for the shale industry is likely to stay essentially flat in 2019,” Rystad analysts said. Offshore OFS may feel the impact of price declines, but the sector is projected to grow by 4% this year. 

“Many would expect offshore spending to be cut as drastically as shale, but offshore budgets were at a 10-year low last year, after four years of intense cost focus, and from that level you don’t need much additional activity or inflation to drive up the market,” said Rystad’s Audun Martinsen, head of OFS research.

Several onshore E&Ps already have signaled lower spending in 2019, he noted.

“We saw the tendency already last month that the shale service market started to hit the brakes. The number of fractured wells per day dropped from an average of around 50 wells per day to 44 wells per day, and fracture service pricing continued to fall in the fourth quarter of 2018.

“For the full year of 2019 we expect more or less the same number of wells completed, at around 20,000 wells, and we do not anticipate seeing utilization returning to the levels as seen in early 2018.”

Offshore capex likely will be driven by exploration and greenfield projects, while operational expenditures (opex) should swell on cost inflation, more fields coming onstream and a buildup of work that needs to be completed.

Still, higher oil prices could direct more capex back to onshore development.

According to Rystad, a $64/bbl Brent crude price would result in both unconventional and offshore growing at around 5%. However, in a scenario where Brent climbs to $70/bbl, the shale/tight oil and gas industry could achieve 14% growth.

“As long as oil prices are below $60/bbl for Brent, it could be interesting to take a second look at service contractors exposed to the offshore sector to see what they have to offer as compared to service companies exposed to shale,” Martinsen said.

Don’t Mess With Texas (Permian)

In the U.S. onshore, “nobody will mess with Texas when it comes to oil production” this year, according to TRC Cos. Inc. experts. The Lowell, MA-based company offers engineering, environmental consulting and construction management.

“The rig count in Texas will remain the highest in the United States, with half of the 1,070 rigs currently in operation across the nation,” said TRC’s David Sowards, director of business development.

However, the hitch is where commodity prices may be. Higher prices equals more E&P activity. While lower natural gas prices have been sustained overall, oil prices began the new year with their first meaningful rally in three months, Goldman Sachs noted. There also is “encouraging evidence” that production reductions by the Organization of the Petroleum Exporting Countries (OPEC) has begun.

OPEC on Thursday in its Monthly Oil Market Report said output in December plunged by 751,000 b/d to nearly 31.6 million b/d led by top exporter Saudi Arabia, which reduced output by 468,000 b/d to slightly more than 10.5 million b/d.

The market may begin to balance this year, if E&Ps don’t overextend themselves on spending. Otherwise, they may struggle to improve shareholder returns, said Moody’s Investors Service’s senior analyst Amol Joshi.

“E&P investors looking for higher shareholder returns will continue to wait in 2019, despite strides in capital efficiency and higher commodity prices since the 2015-16 downturn,” Joshi said. Producers this year “will continue to exercise spending discipline and focus on capital efficiency.”

Labor inflation has increased operating costs, while rising production mostly has contained costs/unit. It costs more to drill and complete wells because of higher demand for OFS, even though E&Ps have offset some of the costs on efficiencies.

“Still, elevated oil prices through most of 2018 did not benefit many producers in the Permian,” Joshi noted. Permian-based E&Ps increased output beyond takeaway capacity, “and higher transportation costs will continue to hurt profitability in 2019, while insufficient takeaway capacity could stifle E&P growth plans.”

Pipeline Constraints Souring Investor Expectations

Onshore pipeline constraints have “soured investors’ expectations” about near-term earnings potential,” the Moody’s analyst said. A weak investor appetite could make some operators “less inclined to try and raise capital, and could even temporarily dampen E&P consolidation.”

A return to higher prices ultimately could enhance shareholder returns, “but only when investors feel assured that falling prices will be temporary, and that surging prices will persist for longer.”

The infrastructure conundrum may face Permian operators through at least the first half of the year, according to Goldman Sachs.

The logistical constraints that hindered Permian growth will ease by 3Q2019 as new pipelines come online, with this capacity increase larger and sooner than expected through most of 2018,” Goldman analysts said. That could mean less production growth would be needed from the other two big U.S. oil plays, the Bakken and Eagle Ford shales.

While oil and gas infrastructure projects are proceeding, with more in the queue, “delay can be costly,” Deloitte LLP’s Duane Dixson warned. Dixson is the consultant’s oil, gas and chemicals leader. “No one in oil, gas or chemicals development can afford to ignore how this plays out, impacting price spreads and physical capacity to move products.”

Look for capital expenditures by the OFS and E&P sector to be bumpy until there’s more certainty about infrastructure, and as producers attempt to match cash flow to growth.

Last year’s recovery in commodity prices and cash flows was good news for the sector, but the “challenge now will likely be to translate that into sustainable profitability and returns,” Dixson said.

Natural Gas Grabbing Spotlight

Prognosticators expect natural gas to take more of the spotlight in 2019, not only because of liquefied natural gas (LNG) export start ups but on petrochemical expansions and increased pipeline deliveries to Mexico.

In addition, associated gas production from the oil plays over the longer term looks “robust,” said Raymond James & Associates Inc. analysts. The market “needs only modest supply growth from Appalachia (and likely declines in most other gas plays) to balance...We expect 2019 should prove to be a positive year for natural gas demand as both exports to Mexico and outbound LNG tanker activity ramp up.”

Expect the United States to export more natural gas, oil and refined products in 2019 than ever before, “with the volume of crude oil exported 10 times higher than it was in 2013,” predicted TRC President Ed Wiegele.

One angle that TRC’s experts also are following is potential federal action regarding gas pipeline safety. Operators are facing more scrutiny after recent pipeline-related tragedies, including last year’s Merrimack Valley gas explosions in Massachusetts.

“2019 begins the quadrennial reauthorization of the nation’s Pipeline Safety Program,” said TRC’s Jeff Wiese, vice president of integrity services. “Combined with the impetus provided by the recent gas distribution incident in Massachusetts, new mandates from Congress seem inevitable.”

At least one final rule is expected soon, “undoubtedly the natural gas transmission rule that will require a pipeline operator to reconfirm a system’s maximum operating pressure using verified records,” Wiese said.