The second quarter earnings season is likely to offer few surprises, as U.S. producers continue to preach capital discipline and pull the reins on developing assets in a low-priced, constrained environment, particularly in the Permian and Appalachian basins.

Kinder Morgan Inc. was kicking off U.S. energy earnings season on Wednesday, with No. 1 oilfield services (OFS) giant Schlumberger Ltd. gearing up for Friday.

Expect a “messy” quarter for the exploration and production (E&P) sector, said Jefferies LLC analysts. Weak natural gas liquids (NGL) and Waha natural gas pricing have taken their toll.

“Once again, E&Ps have been left in the dust by crude, and it feels to us the market doesn’t want, or more importantly need, the crude supply that the U.S. onshore can deliver at $60/bbl-plus West Texas Intermediate,” Jefferies analysts said. “Unfortunately, it’s the same story for gas.”

Operators exposed to NGL pricing aren’t likely to have strong results, Goldman Sachs analysts said. Weak demand, high inventories and ethane oversupply are driving weaker NGL prices at the country’s largest fractionator, Mont Belvieu in Texas, resulting in a 22% decline in per-barrel prices between April and June.

“We view this collapse in prices as most negative for liquids-rich gassy producers” and for oily E&Ps with a lot of NGL exposure, Goldman analysts said.

While summer is typically weak for NGL prices, there are export constraints, cracker projects that have slowed, new pipeline/fractionation capacity and strong production exacerbating the issue, according to Raymond James & Associates Inc.

On the natural gas side, Waha hub prices tracked near zero for most of the second quarter, boosting marketing for several players including Energy Transfer Partners LP, Enterprise Product Partners LP and DCP Midstream LLC, according to Raymond James.

The third quarter, however, “may be the last ”boom’ quarter” for the midstreamers as the 2 Bcf/d Gulf Coast Express is set to come online by October to move Permian Basin volumes to the Texas Coast. How quickly it fills and whether more constraints develop ahead of the ramp of the 2 Bcf/d Permian Highway Pipeline in late 2020 likely will be a big topic during the conference calls.

Besides pressuring Permian gas producers, BMO Capital Markets analysts warned that weaker gas and NGL pricing is slamming cash flow for the Appalachian gas heavies.

“We’d expect lower activity, capex and production” to be reported during the second quarter calls, said analysts led by Phillip Jungwirth. “Based on our oil and associated gas forecasts through 2020, we see little relief in sight.”

Gas and NGLs comprise around 30% of estimated 2019 sector revenues for public E&Ps “and will weigh on cash flow even for some oil producers.”

BMO’s team expects only a few E&Ps “to positively surprise” with their second quarter results. Basically, $55/bbl West Texas Intermediate (WTI) is not good enough for E&Ps to execute.

“The generalist is the white whale of E&P with few companies able to catch this investor base,” Jungwirth said. “While the sector can achieve strong production growth at $50-55 bbl WTI, we estimate corporate metrics aren’t attractive versus competing sectors at this price,” as $60-65/bbl is needed for large-cap E&Ps to achieve a “relatively attractive” price/earnings ratio, free cash flow yield and return on equity.

“Capital discipline was supposed to bring better equity performance, but results are mixed to date,” Jungwirth noted. Another “step change in capital discipline is needed to support higher oil prices and translate to more competitive corporate metrics for public E&Ps.”

The “big theme” overall for the second quarter, “in addition to the ongoing discussion about slowing production growth in favor of capital discipline, will be talk of consolidation, particularly in the Permian Basin,” said NGI’s Patrick Rau, director of strategy and research.

Occidental Petroleum Corp.’s proposed $57 billion takeover in May of Anadarko Petroleum Corp. “really kicked things off” this year in terms of mega mergers and acquisitions (M&A) followed by the merger of Texas operators Callon Petroleum Co. and Carrizo Oil & Gas Inc.

“Everyone wants to know, who is next?,” Rau said.

Consolidation also is on the minds of the OFS sector, which has been the victim of its own success as its improved rigs and technology allow E&Ps to recover more output at a lower cost. In June, Houston-based C&J Energy Services and Keane Group Inc. agreed to combine their completions and production services operations across every major producing region in the Lower 48, basically another merger of equals.

Expect more of the same, Rau said.

High on the list of quarterly topics will be the outlook by Permian producers as rigs are falling and natural gas pipeline constraints continue. Small-to-mid-cap, or SMID, producers have been at a disadvantage as they are perceived to lack the scale to compete against their large-cap brethren.

“Production growth out of the Permian has been slowing because of a number of different reasons, not the least of which is a focus on capital returns and reduced costs,” Rau said. “Consolidation is a relatively straightforward method to improve on that front, especially for companies that have similar acreage positions.”

Still on the minds of investors is the pledge to hold the fort on capital expenditures (capex). WTI crude averaged close to $68/bbl during 2Q2019, versus $65.50 in the first quarter “but that probably isn’t enough to lead to a massive increase in capex budgets for the year,” Rau said. “The emphasis for E&P remains less, not more, in terms of drilling activity.”’

As most E&P budgets were front-end loaded for this year, “there should be a natural fade on production going into and extending throughout 2020, everything else being equal. That would likely be heightened if we see another wave of consolidations throughout the industry.”

Goldman Sachs analysts led by Brian Singer also question whether investors will be convinced that U.S. E&Ps will remain within their capex plans as they spent more than half of their 2019 budgets in the first six months.

“There are lingering investor concerns that front-end loaded capital spending could still lead to capex budget raises later in the year, making second quarter results and guidance/commentary around second half spending an important catalyst for shares,” Singer said.

Lower 48 E&Ps during 1Q2019 spent 26% of full-year budgets, and they spent around 26% of total spend between April and June. Investors are looking for “multiple quarters of execution before awarding credit to companies for capital discipline, so it is unclear whether 2Q2019 will be the catalyst for a meaningful shift in investor credit.”

For the OFS sector, the second quarter was disappointing once again, according to Raymond James. Optimism faded with the decline in WTI pricing.

“The quarter itself played out only slightly below expectations due largely to a weaker June,” analysts said. “However, a far bigger hit will be felt for third quarter and fourth quarter estimates. With the oil volatility seen to date, it now appears unlikely that 2019 will see a late-year ramp in service activity that many estimates previously reflected…” The OFS sector is likely to enact more cost-cutting measures through the year, a “theme for the past five years,” and this earnings season should bring about even more discipline.

“We now expect the rig count to move lower to the end of 2019,” with a 5% decline in 3Q2019 and a 2% decline in the final three months. A moderate build in drilled but uncompleted wells, or DUCs, between October and January has reversed.

“We expect completions activity will track drilling into December, meaning already challenged markets such as fracture sand and pressure pumping will stay depressed through 2019,” according to Raymond James.

The risk/reward for E&P earnings is skewed to the downside in part because of the less positive rates of change for well productivity, the absence of OFS cost deflation or visible efficiency gains, as well as the need for production estimates to be trimmed to support higher commodity prices, BMO’s Jungwirth said.

Few E&Ps have been able to surprise to the upside “in terms of capital efficiency or growth, while exploration/delineation catalysts are lacking,” he noted. Based on an early review of 2019 well productivity data, only the Permian Basin’s Delaware sub-basin appears to still be showing improvement at the margin.

“The bottom line is that the sector needs another step change in capital discipline with spending to cash flow alone is not enough to attract generalist interest in the space.”

Evercore ISI’s James West, whose team follows OFS activity, said the U.S. land market’s outlook is “fairly murky,” but one thing is clear: U.S. onshore activity is likely to slide lower through the end of the year as budgets are exhausted.

The investment case for energy “is currently in shambles,” West said. “This is the big picture. Investors believe energy is ”uninvestable,’ sentiment lies at multi-decade lows, and while valuations rest at similar lows, the catalysts to change are more structural in nature,” including revisions to executive compensation.

The competition for investment dollars, according to West, “will continue to favor those industries with superior corporate governance and higher return profiles. If M&A is not part of this process the industry has failed to understand that there is too much capital chasing too many low return opportunities.”