North American explorers need natural gas prices of “at least” $3.00/Mcf and a crude oil price above $50/bbl to achieve a meaningful return on capital, based on a review of more than three dozen operators by Moody’s Investors Service.

Exploration and production (E&P) companies have improved cost structures substantially since the commodity price collapse in 2014. However, a review of the expected performance of 37 operators using different commodity price scenarios determined that overall, higher sustained prices are needed.

Capital efficiency was measured using the leveraged full-cycle ratio (LFCR) metric, which is a function of operating cash margins and finding/development (F&D) costs. Analysts calculated the LFCR by dividing the leveraged cash margin for an E&P by its three-year average all-sources F&D cost.

“North American E&P companies’ focus on cost reduction has brought their capital and operating expenses down substantially since mid-2014, when oil prices began to collapse, but further reductions will be difficult to achieve,” said Moody’s Vice President Sreedhar Kona. “As a result, further improvement in firms’ drilling and completion costs, leveraged cash margins and LFCR and will depend almost entirely on commodity prices being sustained at or above current levels.”

Through 2015 and 2016, capital and operating cost structures were cut sharply. About 40-50% of the cost optimization realized following the price downturn came from efficiencies and structural improvements, including reduced cycle times, technological improvements, better completion techniques, automation and supply-chain savings.

Savings also came from price concessions made by oilfield service (OFS) operators, many of which worked at sharply reduced rates through the downturn.

However, in measuring E&P capital efficiency return on investment, most companies in North America “worsened sequentially through 2015 and 2016, mainly because the fall in commodity prices far outpaced the improvements in cost structures.”

E&P cash margins and consequently the LFCR are functions of commodity prices, so all things being equal, the trend in LFCR follows the trend in prices, Moody’s analysts noted.

Additionally, finding and development (F&D) costs are dependent on the overall reserves additions during a period, and the reserves in turn are a function of the average commodity price for that period.

Analysts expect average all-sources F&D costs should begin improving, but leveraged cash margin improvement largely will depend on prices. More material operating cost reductions “will be hard to achieve,” as LFCR improvements are possible only through improving commodity prices. In addition, drilling efficiencies may be offset by higher OFS costs.

“Meanwhile, sustained downward pressure on commodity prices, an increase in capital or operating costs not accompanied by an increase in commodity prices, or the pursuit of growth by drilling in noncore acreage could all weaken E&P companies’ LFCRs.”