E&Ps appear to be back in the business of spending money.

After unprecedented back-to-back years of double-digit spending declines, upstream spending is set to increase, led by North American (NAM) E&Ps. But analysts caution that service costs will also make up part of the spending increase.

While E&Ps have benefitted from oilfield service pricing near or below breakeven levels, a survey by Barclays released Jan. 9 shows that 79% of E&Ps expect oilfield service costs to increase in 2017. A majority of operators, about 55%, expect modest increases of up to 10%.

Overall, global upstream spending is expected to increase 7% after back-to-back declines of 26% in 2015 and 23% in 2016, according to Barclays’ survey.

Barclays’ survey shows spending in NAM will see a sharp increase, with E&Ps upping their budgets by 27% in 2017 after slashing 38% in 2016. However, only about 15% to 20% of E&Ps have formally announced their 2017 budgets so far.

“Buoyed by lower cost structures, higher prices, the need to grow production and just more optimism post-OPEC, we expect operators to step on the accelerator as we enter 2017,” said David Tameron, senior analyst with Wells Fargo Securities.

International spending will increase 2% in 2017 while offshore spending is poised to fall by up to 25%.

OPEC’s decision to compete for market share in the past few years may have a couple of major, unintended consequences. While U.S. shale production may not have been the target of OPEC’s production frenzy, well costs in the U.S. have fallen by 40%, J. David Anderson, Barclays’ oilfield services and equipment analyst, said during a Jan. 10 press call.

“The industry has seen step changes in efficiencies over the last two years in drilling and completions,” he said. “OPEC is about to find out just how efficient U.S. shale has become over the last two years.”

NAM large-cap companies, in particular, are ramping up their spending by 58.5%, the largest percent increase among any group Barclays surveyed.

“The important number here is large-cap E&Ps,” Anderson said. “We see large-cap E&P spending up almost 60% in 2017. That is offset by major oil companies spending being flat, which tend to be more Gulf of Mexico driven.”

However, NAM upstream spending is dictated by the cash flow generated by producers, making most of their spending oil-price sensitive. It’s also one of the most cyclical of any region because companies tend to spend all of their cash flow—and often more than their cash flow—on drilling and completing wells.

The Spendthrift Industry

In the past four years, large-cap E&Ps spent 120% of cash flow and small- and mid-cap companies have spent 154% of cash flow.

However, in 2015 and 2016, E&Ps raised about $40 billion through equity, turning upstream leverage levels to more healthy proportions, said David Deckelbaum, an analyst at KeyBanc Capital Markets.

Among E&Ps that KeyBanc cover, companies outspent cash flow by $36 billion from 2013 to 2015, or about 54% annually. In 2016 overspending cash flow lessened to about 17%. In 2017, those companies are expected to spend within cash flow.

Deckelbaum expects to see debt to continue compressing in 2017 and to a lesser extent in 2018.

“Healthy leverage metrics combine with over $37 billion of liquidity in our coverage, a 20% increase since the end of 2015,” Deckelbaum said. “This set-up should allow for palatable rig additions and increased M&A activity.”

KeyBanc estimates capex for companies covered will rise by 28% in 2017 and another 30% in 2018. Meanwhile, production will grow in the double digits both years.

With increased activity, Barclays’ E&P analysts see U.S. shale oil production increasing 600,000 barrels per day (bbl/d) by year’s end. That figure could rise as high as 750,000 bbl/d if oil prices increase by another $5, Anderson said.

Bit By Bit

As U.S. production is poised to turn the corner, the U.S. land rig count has already increased by 70% from its low point. Barclays expects another 220 rigs to be added by year-end 2017.

Barclays forecast the U.S. land rig count to average 730 rigs in 2017, up from previous estimates of 700 rigs.

“We see finally for the first time the economic shifting to oilfield service companies that we have not seen in a number of years,” Anderson said.

Oilfield service costs, consolidation and labor will now become major themes for the year ahead.

As many as “half a million jobs have been lost in the downturn,” Anderson said. “Schlumberger alone has let go of 50,000 people globally. The question is how many have permanently left the industry and will there be enough qualified labor to quickly meet rising demand?”

Oilfield companies are presumed to increase costs, but not dramatically.

“Most operators at this point are baking in a maximum of 5% to 10% service cost inflation next year, mostly in the Permian,” Deckelbaum said.

E&Ps have put forward a narrative over the past 12 months that most of their cost savings are structural—based on technology and innovations.

“The big debate over the next 12 months is the 40% cost savings in North America, which percentage of that is structural and which percentage of that is cyclical?” Anderson said.

Some operators are already seeing higher pressure pumping rates, citing 10% to 20% pricing increases to start 2017, Tameron said.

Oilfield service margins are currently at a historic low and this year they’re forecasted to be more than 20% below their historical average.

“Just about every oilfield service company operating in North America today is at negative EBITDA. They’re actually below cash breakeven prices,” he said. “This is unsustainable, clearly. So we think you are just about to see service cost increasing,” Anderson said.

Those margins are likely to reverse as supply and demand balances shift in 2017 and 2018.

“We believe that the timing and magnitude of service cost pressure, reflected broadly in our models, might be sooner and more punitive than current Street expectations,” Tameron said.

As a result, many oilfield service companies have filed for bankruptcy, but many continue to stand independently.

“We do think there’s consolidation to come,” he said.

Darren Barbee can be reached at dbarbee@hartenergy.com.