Natural gas and oil operators may prefer to talk about 2021 than second quarter performance as earnings season begins, with low commodity prices and Covid-19 literally sucking the energy out of the room.
Halliburton Co. kicked off earnings season for the oilfield services (OFS) sector on Monday, with the deluge of results to follow from exploration and production (E&P) operators and the midstreamers.
Operators already have signaled huge writedowns for 2Q2020 as the value of their oil and gas assets has plummeted. The loss in demand has been clear since the pandemic began sweeping the country, and the impacts became more evident beginning in April.
The questions to be answered are when and how the energy sector may again gain traction. Royal Dutch Shell plc CEO Ben van Beurden reiterated this month that he expects the pandemic to impact oil and gas demand for years. The Shell chief in April had said the world was in a “crisis of uncertainty” because of Covid-19. He re-upped those sentiments recently in an interview with IHS Markit Vice Chairman Daniel Yergin.
More quarterly earnings coverage by NGI may be found here.
“It’s most likely not going to be a V-shaped recovery,” van Beurden said. “But in general, energy demand and certainly mobility demand will be lower even when this crisis more or less is behind us. Will it mean that it will never recover? It’s probably too early to say. But it will have a permanent knock for years.”
BP plc CEO Bernard Looney also recently said he expected some of the global decline in oil demand may last beyond the pandemic.
Don’t Look Back
Tudor, Pickering, Holt & Co. (TPH) analysts said the focus for operators in the 2Q2020 conference calls may be less on what has happened and more on how they plan to succeed going forward.
“In the near term, we continue to see more downside risk to production in the second half of 2020, given limited capital allocation to the drillbit and steep corporate base declines,” the TPH analysts said.
“Thematically, discussions around federal land exposure feel more balanced in our view versus a month ago as investors wait for further clarity on details around policies as it relates to permits versus leasing,” the analysts said. “Additionally, clients continue to dig into capital allocation and production impacts” if the Dakota Access Pipeline (DAPL) pipeline that carries Bakken Shale crude is shuttered into 2021.
Overall, expect to hear “constructive dialogue from a macro perspective for 2021, with upstream management teams messaging maintenance capital as the limit to growth next year.”
BMO Capital Markets analyst Phillip Jungwirth said the second quarter could be summed up in one word for E&Ps: ugly. Oil prices declined by 13% from the first quarter, with capital expenditures off 46% overall from a year ago, Jungwirth noted. Completion activity stalled, and many E&Ps shut-in substantial Lower 48 oil output into June.
The second half of 2020 “begins the healing process,” Jungwirth said.
Analyst Gabriele Sorbara of Siebert Williams Shank & Co. LLC expects the second quarter results to be “largely overlooked” because it likely will be the low point for the year.
“Instead, we expect investors will focus on companies best positioned” into 2021, “especially those reactivating activity with an upward bias to oil production estimates,” Sorbara said.
“In general, the industry is de-emphasizing production growth and will be slow to return to growth mode. The focus has shifted to free cash flow and return of cash to shareholders while maintaining strong balance sheets and liquidity positions.”
Sorbara expects to hear about the E&P “maintenance mode programs” even with pricing improvements. In addition, lower OFS costs and a backlog of drilled but uncompleted wells, i.e. DUCs, should “provide a tailwind for more efficient 2021 programs.”
For the bellwether OFS sector, which signals spending by E&Ps, second quarter results may be dismal.
“Let’s don’t kid ourselves,” said Evercore ISI analyst James West of the OFS sector. Second quarter results “will be atrocious relative to 1Q2020 and certainly 2Q2019. But we all know this and so does the market. We expect actual results to be mostly in-line with consensus…”
The reductions in spending and earnings, however, “could have been dramatically worse if the companies hadn’t acted swiftly and with determination,” West said. “A key message this group will deliver is a good portion of the expense reductions are structural in nature and will allow them to produce free cash flow even in a slow recovery.”
Evercore’s analyst team sees a major industry restructuring unfolding. It begins with widespread bankruptcies, said West. And indeed, dozens of E&Ps and OFS operators have succumbed to bankruptcy since early this year. Another step in the process would be “massive asset retirements,” followed by a “major” merger/acquisition cycle.
West’s prescient statement came before Chevron Corp. on Monday snagged the biggest global energy deal since the downturn. Chevron proposed a $5 billion stock-only takeover of Noble Energy Inc., which carries an enterprise value of $13 billion.
Of OFS results for the second quarter, the TPH analysts recommended everyone “buckle up. Mucho turbulence expected this earnings season…
“While the U.S. onshore completions trough appears to be in the rearview, and U.S. rig count should bottom soon(ish), the international and offshore activity outlooks remain stubbornly bleak.”
In addition, as Covid-19 cases have surged recently, crude demand could shrink again, leaving “many investors apathetic to and/or anxious about the trajectory of OFS stocks from here.”
Better funded OFS operators should be able to weather the financial storms and emerge with improved cost structures.
“There will invariably be landmines during the 2Q2020 earnings season given the magnitude of the recent activity and pricing movements,” the TPH analysts said. Most of the concern is for U.S. land drillers through 2021.
Shrink To Fit
As E&Ps have sharply reduced spending, Rystad Energy said the follow-on impact will be the loss of global project sanctioning, which is now expected to be down more than 75% from 2019.
Rystad’s team now estimates the total sanctioning value will be around $47 billion, which might have been lower if not for recent projects sanctioned in Norway and Russia.
Around $27 billion is pegged for new offshore projects in 2020, with $20 billion for onshore. That compares with 2019, when total sanctioning value reached $197 billion, including $109 billion for the offshore and $88 billion to onshore projects.
Rystad’s forecast is based on a scenario in which Brent oil averages around $40/bbl this year.
“At the beginning of this year, the project commitments forecast for 2020 were expected to be comparable to 2019, but the industry downturn thanks to Covid-19 has caused commitments to fall sharply,” said Rystad’s Karan Satwani, energy service analyst. “Going forward, Rystad Energy estimates that sanctioning will not pick up again and recover to 2019 levels anytime soon.”
In a bright spot for the United States, LLOG Exploration Offshore LLC in June sanctioned the Taggart deepwater development for the Gulf of Mexico. The plan includes tiebacks for two existing wells to the Williams-operated Devils Tower spar. Rystad estimated the development would cost more than $300 million.
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