There’s no shortage of pessimism going around. Such has been the resilience of U.S. unconventional production that a not uncommon view is crude oil prices are likely to be range-bound or under pressure in the near to mid-term. The rapid rebound in U.S. unconventional production will sop up demand, goes the thinking, and a relaxation of current OPEC cuts will more than meet any gap in supply.
A recent analyst report came out with a heading that warned: “The Only Winning Move Is Not To Play,” citing potential U.S. onshore oil growth of up to 1.5 million barrels per day from December 2016 to December 2017.
Another long-time industry observer said that “the negativity is controlling every-thing” in terms of sentiment surrounding events in the crude market.
Obviously, rising U.S. volumes justify concern over the path and timeframe to rebalance the global crude market. Similarly, market participants seek clarity as to how OPEC and its non-OPEC partners plan to exit from their agreed production cuts currently extending through March of next year. But, trends rarely extend in straight lines for long and much can happen over the next three quarters.
As of this writing, the energy sector is for sale, with little market differentiation by industry subsector. Disconnects abound. If U.S. onshore oil output is to continue ramping higher, for example, rising money flows into the oilfield service sector should be reflected in improving prospects for North American land-oriented stocks. So far, that’s not showing up in the stocks—typical of a bear market.
For those concerned that too much capital is being directed to refurbishing land rigs and pressure pumping equipment, with a negative impact on sector margins, a logical hedge would be a position in global oilfield products company Forum Energy Technologies. However, the provider of mud pumps and valves used in drilling, as well as fluid ends and manifolds for pressure pumping, has also seen its stock mauled by the bear.
To counter oversized growth, limits on capital are the ultimate constraint. Given crude prices’ slide lower in late May/early June, even the rate of ascent of Permian activity is set to slow somewhat, according to analysts at research firm AllianceBernstein LP.
Rig additions in the Permian are expected to “slow significantly in the coming months” from a 315 rig count for the basin in late May, said a Bernstein report. The report said that at assumed $50 oil, the industry could roughly support its 315 rigs, but it estimated a $70 per barrel price would be needed for the industry to push the rig count higher to 400 rigs.
The math in the Bernstein report goes roughly as follows. It estimates that about 73% of total industry capex is allocated to shale. With the percentage of industry rigs working in the Permian tending to level out at 42%, this suggests that about 30% of total spending goes to the Permian (73% x 42% = 30.6%).
On average, rigs in the Permian can drill about 17 wells per year, which at $7 million per well (including facili-ties) translates to about $120 million per year in spending for each rig, the report said. Assuming an outspend of upstream cash flow of 7%, cash flow is roughly sufficient to support 300 rigs, the analysts estimated, adding that over half of U.S. upstream capex would be needed to sup-port 400 rigs.
Bernstein forecasts that sliding oil prices and cash flow will constrain Permian activity to fewer than 400 rigs and “mute production growth” in 2018. “If a combination of this more moderate growth trajectory and OPEC cuts are successful in reducing inventories, price will rise and rig additions will resume.”
Tudor, Pickering, Holt & Co. (TPH) also sees price and cash flow as the ultimate regulators. Based on client conversations, it said investors “may need to see crude drop and stay in the low $40-per-barrel range before re-engaging in the sector. At this price most, if not all, of our covered names will likely be forced to cut activity and moderate growth going into 2018.”
What’s the pushback from E&P management teams?
“The current high-$40s per barrel to low-$50s per barrel seems to be the zone of inertia where no one will make a move to cut spending,” said TPH. “The anxiety of ‘going first’ and [risk] having your stock get hammered seems to be keeping the throttle pretty much wide open. The aggregate message from the market is ‘slow down,’ but individually companies remain firmly in growth mode.”
Anyone set to tap on the brakes?
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