FORT WORTH, Texas—Sixty dollars is the new $90, declared Raymond James analyst Andrew Coleman to a crowd of Permian Basin players at Hart Energy’s DUG Permian conference last week. His prediction is predicated on a model that lower service costs and drilling efficiencies will reset acceptable operator cash margins closer to $60 WTI.
“Our belief is that high-grading [acreage] and cost reductions will allow the sector to recalibrate at $60 oil,” Coleman said.
Wall Street has sent a signal to operators that they cannot outspend capital, and as such the Raymond James model is “definitely more focused on cash margins than EBITDA margins,” he said. “We want to make sure that the next barrel produced will cover the entire cost in the [value] chain.”
As the forward curve is at $60 for the next couple of years, “the assumption is we have to live in a $60 world if we’re going to have a sustainable business.”
Coming out of first-quarter earnings calls, the industry mean $10 cash margin reported doesn’t seem all that positive, but Coleman pointed out that WTI averaged $48 to $50 during that period. Now that oil is toying with $60 per barrel, second-quarter margins stand to improve by 60% over the first quarter metrics, he said.
“A 60% improvement in margins is a much-needed and welcome relief as opposed to the numbers we saw coming out of the fourth-quarter.”
In addition to service cost reductions, he anticipates reductions in transportation costs, lease operating expenses and general and administrative expenses (G&A) to further enhance cash margins.
“If companies potentially have 60% more cash to spend, is that enough to pass muster and drill new wells? It doesn’t tell us we’re going to see a massive rush to put rigs back to work, but it shows that at least the worst is behind us and, at $60 oil companies can maintain their production levels. With additional cost savings, they can start to squeeze additional growth.”
Tudor, Pickering, Holt & Co. analyst Travis Nichols, also speaking at DUG Permian, said capital efficiency dominates the conversation among E&P executives and investors. “The basic question we ask ourselves everyday is, ‘Are we using the capital we’ve been entrusted with in the most productive, efficient and prudent way possible?’”
But break-even economics are a moving target, he said, and $60 oil is not the same on the way down as it is on the way up. Break-even economics are driven by a combination of oil price, estimated ultimate recovery per well, and well cost, he noted.
So where is price headed? That depends on who you believe, he said.
“The strip says we’re going back to $68. The median analyst on Wall Street says we’re going back to $75. Even our own analysts at Tudor Pickering Research say we’re going back to $90. So even the smartest people who study or trade on it can’t seem to agree.”
Break-even prices in the Permian have improved between $10 and $20 across the board almost entirely on the back of a deflation in service costs, he said, but “the reality is a lot of service providers are operating at or near a zero percent margin now, so that 20% [reduction] comes right out of their pockets, which just isn’t sustainable, so we expect that will go back up as industry recovers.”
However, a reduction in drilling and completion (D&C) costs have occurred over a two-year period even before the downturn, and in spite of industry moving toward longer laterals and enhanced completions. This innovation to push down costs is sustainable toward lower break-even economics.
“Our industry finds ways to solve our problem and get the prize. If you’re Saudi Arabia and you’re watching, you’re not the only one that can make money at $60 oil,” Nichols said.
“There are low-cost resource plays all over the basin,” he said. “U.S. oil supply forecasts are all over for the second half of this year, but we will need a recovery in U.S. supply to meet global demand growth. American innovation is still hard at work, and will push break-even costs down even more.”
Contact the author, Steve Toon, at stoon@hartenergy.com.
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