The end-of-year earnings reports for North America’s natural gas and oil industry may be ugly if the preliminary results issued by Chevron Corp., Royal Dutch Shell plc and Appalachia-focused EQT Corp. are any indication.

The “official” start of the 4Q2019 earnings season begins with Schlumberger Ltd. kicking things off early Friday, followed by Halliburton Co. on Tuesday, and Baker Hughes Co. and Kinder Morgan Inc. on Wednesday (Jan. 22).

Global bellwether Schlumberger “has the best potential catalyst (and thus the most risk of disappointing) as it feels like everyone is waiting for more meat on the bone with respect to the company’s new strategy for competing in the North America land market going forward,” according to Tudor, Pickering, Holt & Co. (TPH).

In addition, analysts are “anxious about the impact that continued North American completions activity/pricing headwinds will have on Halliburton in the first half of 2020.”

Industry insiders are bracing for negative reports, particularly after some heavy hitters have signaled as much. Chevron last month said it would write down as much as $10-11 billion in the final period, with more than half related to impairments to shale and tight natural gas prospects in Appalachia.

Shell warned it may write down up to $2.3 billion for 4Q2019 because of a mediocre economic outlook and trading headwinds in the natural gas division, including for liquefied natural gas (LNG). And EQT, the largest U.S. gas producer, piled on, indicating it would impair up to $1.8 billion of assets in the final period partly due to low prices.

Corporate governance and free cash flow (FCF) generation likely will be key themes for exploration and production (E&P) operators as well as oilfield service (OFS) companies, but it all comes back to natural gas and oil prices.

Natural gas oversupply is pointing to a down year for Henry Hub prices, according to analysts with Raymond James & Associates Inc.

“In contrast to our upbeat view on the global oil market, we are much less enthused about U.S. natural gas,” analysts said, with the full-year 2020 Henry price seen averaging $2.30/Mcf, down 13% from 2019 levels. By comparison, Goldman Sachs is expecting Henry to average $2.20 this year, and the U.S. Energy Information Administration in its Short-Term Energy Outlook issued Tuesday trimmed its Henry average to $2.33/MMBtu for 2020, a 24-cent decline from the 2019 average.

The expectation of a weak gas price environment this year follows higher-than-expected inventory levels at the end of 2019, as well as increased Permian Basin associated gas reaching the market following pipeline additions in late 2019. A third factor is the increased gas flaring set to be captured in the Bakken Shale.

“That said, as inventory levels moderate in 2020, and growth in associated gas production slows, we expect gas prices to improve modestly in 2021 and beyond,” the Raymond James analysts said.

Domestic gas supply is forecast to increase by 5.5 Bcf/d “over the next two years combined, which is just over half the increase from 2019 alone.”

LNG, Mexico Demand

The demand side for the gas equation is in relatively solid shape, led by the continued ramp of Lower 48 LNG exports, which Raymond James is forecasting to surpass 9 Bcf/d in 2021. Pipeline exports to Mexico, along with petrochemical expansions also should boost gas consumption.

“As always, the No. 1 wildcard for gas prices is weather,” said the Raymond James team. The baseline forecast assumes 10-year normal weather.

For the oil market, fundamentals point to a more bullish 2020. “Our outlook for 2020 can be summarized as positive on oil, negative on gas, and selective on stocks.” Analysts expect West Texas Intermediate to average $65/bbl in 2020, exiting the year north of $70.

Analysts are envisioning a recovery toward the end of this year, but no sooner.

“Commentary from various E&P companies about 2020 spending plans, and in some cases actual budget announcements, point to a slow recovery in 2020,” said the Raymond James analysts.

Many E&Ps may be reluctant to increase activity even if there are near-term improvements in commodity prices.

“The fact that initial 2020 budgets are being set under the rather sluggish oil market conditions currently means that any meaningful recovery is likely to be a second-half-of-the-year story,” the Raymond James team said. The domestic rig count may rebound to 1,010 by the end of this year, with the annual average set at 910. However, if oil prices do not increase, “we expect the rig count under a futures strip scenario to average 825 in 2020 and 845 in 2021. Under this scenario, we anticipate that the U.S. would not be able to grow oil production in 2021.”

“We continue to believe 2020 will be a tale of two markets, with North America being a muddle while the recovery should continue in international and offshore arenas,” said Evercore ISI’s James West. “The commodity backdrop is favorable for continued activity growth in those regions,” and an important prop for the OFS sector as it works to improve the returns profile and meet positive FCF generation expectations.

OFS spend this year may fall below maintenance levels, and equipment could decline at a faster rate than demand, leading to utilization improvements, said the Raymond James team.

“For 2020, we expect the entire group to benefit from a bottoming of activity as well as cost rationalization.”

TPH analysts said “what still matters most in the energy space heading into the forthcoming earnings season is getting confirmation (which we think that we’ll indeed hear) from North American E&P operators that they still intend to toe the line on capital discipline, irrespective of any near-term cash flow lagniappe stemming from commodity price spikes or the apparent opening of the high-yield debt market (capital access) window.

“All fingers (and toes) crossed for good measure, please.” The “darkness of the 4Q2019 activity abyss” suggests the OFS sector in particular may need to proceed with caution as the completions supply/demand outlook for this year is not promising.

“That light (you think) you see at the end of the tunnel might end up being a train chugging in your direction,” said the TPH analysts. Last year was brutal for completions activity, “and the pressure pumpers sit in a deep hole that’ll likely take a while to dig out of absent a stout demand surprise.”

While there is attrition in the fracture/horsepower market via retirements, it’s “nowhere near adequate to heal this market in 2020.”

For the midstream sector, operators during the fourth quarter conference calls are likely to face some of the same questions the OFS companies will face, all revolving around slowing E&P growth.

“Although overall lower domestic production growth presents a headwind for the industry, we think the consensus view toward ‘much lower’ marketing/optimization opportunities in 2020 is too bearish,” said Raymond James analysts Justin Jenkins and J.R. Weston.

“Aside from how high-level guidance announcements impact their respective companies, we are interested in seeing how general planning begins coming together for 2020. More specifically, while capital discipline is in focus, it will be interesting to see how the market reacts to capital spending guidance, especially with some ‘elevated’ spend in 2020 still lingering.”

According to Alerian energy research analyst Bryce Bingham, the slowdown in E&P growth means the midstreamers have to emphasize capital discipline and how major infrastructure projects are proceeding.

Midstream capital expenditures (capex) are falling as operators no longer have to maximize capex to “keep up with rapid production growth,” Bingham said.

“Several major pipelines have recently been commissioned, with the dual benefit of removing a large capex burden and increasing fee-based cash flows for the companies involved.”

Most of the midstream operators that have provided initial 2020 capex guidance are targeting double-digit spending declines this year over 2019 spend, Bingham noted. On average for 19 companies reviewed, capex is forecast to decline year/year by 31%-plus.