The big-budget slashing has begun in earnest.

Independent E&Ps, among the most prolific out-spenders in the industry, are feeling squeezed as crude prices drop and stress their leveraged portfolios.

With prices still falling, capex cuts are likely bigger than analyst initially expected.

Operators are aggressively chopping expenses to live within their means, said David Tameron, analyst, Wells Fargo Securities.

“We had been looking for perhaps 13-15% reduction in 2015 capital versus 2014 levels,” Tameron said in recap of the 2014 Wells Fargo Energy Conference that ended Dec. 10. “Based on what we heard at the conference, we now think that the number is at least 15%, and we could see levels closer to 20%.”

Recently announced budget cuts range from hundreds of millions to billions of dollars.

Since June, oil prices have collapsed nearly $50 per barrel (bbl). E&Ps will ride out the worst of the oil collapse by narrowing focus, drilling less and counting less-expensive services.

“While not unprecedented, the fall nonetheless had significant impact to equity prices and equity valuations,” said Bob Brackett, senior analyst, Bernstein Research.

Investors think the collapse is due to excess spare capacity, Saudi Arabia’s tactics regarding production and the falling marginal cost of oil, Brackett said.

Wells Fargo’s conference brought out discussions about capital budgets, service costs and 2015 production exit rates.

Deals Undone

M&A activity remains in limbo. Most executives at the Wells Fargo conference did not talk about specific acquisitions or divestitures.

Generally, though, “CEOs and executives said that with the rapid fall of crude price, no one is talking M&A today with the exception of a few highly distressed situations,” Tameron said.

But that raises the question of why to buy a distressed company’s assets.

“Their thought was that distressed companies are getting beaten up for a reason (leverage, lower-quality rock, economics), so why would they want to take on those issues when they already have production and inventory visibility,” Tameron said.

Deals are also being short-circuited by a wide gulf between bids and asking prices.

In the future, the private market may see deals. A number of private pure plays that could add small companies’ acreage as bolt-ons, Tameron said.

Most likely, activity would occur in the Permian, where, according to Concho Resources Inc. (NYSE: CXO), there are 65 private-equity backed entities.

Cutting-Room Floors

ConocoPhillips (NYSE:COP) was among the first major companies to say it would cut its budget after oil began a further tumble in December.

On Dec. 8, the company’s 2015 capital budget fell by $3 billion or 20% to $13.5 billion.

Despite a headline $3 billion cut, the trauma to discretionary spending is much smaller, said Pavel Molchanov, analyst, Raymond James Equity Research.

“Of the $3 billion, a sizable portion—not precisely disclosed, but we think over half—is on ‘autopilot,’ in the sense of spending that's rolling off on soon-to-be-completed long-lead-time projects” in Australia, the Canadian oilsands and Malaysia, Molchanov said.

In early December a slew of companies lined up with announcements that spending was being slashed, though production would rise anyway.

Oasis Petroleum Inc. (NYSE: OAS) said it would reduce capex by 44% in 2015 and was intent on high grading its Bakken core and spending close to cash flow.

Oasis said its initial 2015 capex plans were $750-850 million with annual production growth of 5-10%. The company’s capex guidance for 2014 was roughly $1.43 billion, according to a May investor presentation.

The company remains in a solid financial position with “highly economic acreage, even in a $60-70 WTI environment,” the company said in a December presentation.

Such reductions will be the norm in the Bakken, said Drew Venker, analyst, Morgan Stanley & Co. LLC.

The announcement “is a fairly good proxy for the reduction in the Bakken's growth rate we expect to see in 2015,” Venker said in a Dec. 10 report. “While activity high-grading may push this out to mid-2015, we believe peers will follow suit, spending closer to cash flow and lowering production volumes.”

The Undecided

Some companies are still trying to find the right number, especially as oil prices continues to punish E&Ps.

At the Wells Fargo conference, Bill Barrett Corp. (BBG: NYSE) leaders said the consensus capex for the company is too high. Bill Barrett is running several scenarios to establish its spending by January.

Based on the company's modeling, a 2015 program with three Denver-Julesburg Basin rigs and one Uinta rig would work out to $475 million in capital spending.

Bill Barrett's 2014 budget is an estimated $560-570 million. Tameron said Wells Fargo models consider about $188 million of its 2014 spending as discretionary.

Bill Barrett’s final plan will likely reflect a conservative view toward outspending.

“It's possible capex could come in below $475 million,” Tameron said.

Sanchez Energy Corp. (NASDAQ: SN) anticipates using only operating cash flow and cash on hand to execute its 2015 capital program, said Pearce Hammond, managing director and co-head of E&P research for Simmons & Co. International.

The company’s only significant capital commitment is a 50-well minimum in its Catarina asset. Simmons is modeling $615 million in D&C capex for 2015, down about 22% year over year.

Supermajors such as BP Plc (NYSE: BP) had already announced significant cuts to their budgets, but may revise them further.

In October, BP told investors it might reduce $1-2 billion in capital expenditure across the company in 2015 against guidance of $24-26 billion disclosed in March.

BP said Dec. 10 that it is embarking on a $1 billion restructuring program and plans to review its 2015 budget due to the continuing downturn in oil prices.

“Although the current environment is challenging, BP is well-positioned to respond and manage our upstream business for the long term,” said Lamar McKay, upstream chief executive.

Service And Supply

The tables have turned for operators, which have been pressed by tight markets for oilfield services.

As one CEO said at the Wells Fargo’s conference, service companies are "starting to bring donuts again.”

Weakening E&P budgets are building in expectations that service costs will dip by about 10-20%, Tameron said.

However, such discounts reflect fourth-quarter 2015 versus fourth-quarter 2014 pricing. Months will pass before rates are renegotiated, Tameron said.

However, “some operators actually already started seeing reduction in rig day rates,” Tameron said.

As a result, service companies, too, will be re-evaluating their budgets.

Halliburton Co. (NYSE: HAL) said on Dec. 10 that it would revise its 2015 expectations and its lowering guidance for the fourth quarter of 2014, said analysts John Freeman and Andrew Coleman, Raymond James.

The company expects North American fourth-quarter revenues to remain flat quarter over quarter, Freeman said.

Internationally, Halliburton is having more difficult grappling with the market. The company said revenues will be flat in the Eastern Hemisphere, but pocked by regional downturns in the Europe, Africa and the Commonwealth of Independent States theater, particularly Russia.

Halliburton expects low single-digit revenue to grow in Latin America.

“Bottom line: This downward guidance revision isn't unexpected, and we would expect similar slowed growth rates from other diversified service companies,” Freeman said.

However, Tudor, Pickering, Holt and Co. doesn’t expect lower costs to last, or help, long term.

Oil service costs will be lower for at least 2015 and likely 2016 as well. But if E&Ps are able to realize a 15-20% cost reduction by late 2015, “oil service profits fall to unsustainably low levels.”

“If held there, that would result in equipment [and] companies falling out of the market and in turn tightening supply-demand of services,” the firm said.