The downturn of 2015 has established that shale oil economics in the Lower 48 are solid enough to survive at $50 oil prices.

But behind that story is that E&P spending is continuing to be eviscerated in the U.S. As one analyst put it, 20% cutbacks have lost their shock value. But by summer another surprise might be in store as companies cut what seemed in January to be invulnerable: production.

Ultimately, lower production will help balance out the oversupply depressing prices. Until then, shale success largely depends on where operators drill.

Three distinct sub-plays—Springer in the Midcontinent, Karnes Trough in the Eagle Ford and Nesson Anticline in the Bakken—generate at least a 10% internal rate of return (IRR) at a $50 per barrel (bbl) flat real WTI price, according to a report by Wood Mackenzie.

E&Ps are continuing to trim spending as oil prices languish near $50/bbl. By the second half of the year, some companies won’t be able to maintain their current capex and production will start to descend, too, an analyst said.

U.S. producers appear to be bearing the brunt of capex cuts.

The Lower 48 “clearly stands out as an area where capital spending in 2015 is experiencing an utter collapse,” said Pavel Molchanov, analyst, Raymond James.

Worldwide, budget cuts have been staggering. A Raymond James survey of 34 top-tier U.S. and international companies found that all were cutting capex.

“Just these 34 companies wiped out $100 billion of 2015 spending,” Molchanov said.

Unconventional shale operators have shown they’re nimble enough to survive the freefall in oil prices. But the downturn has set spending levels back to 2010 levels.

Cuts Keep Coming

Molchanov said evidence shows that the U.S. is seeing a far steeper drop in spending than the global industry as a whole, just as it had greater-than-average increases in spending during the 2011-2014 upcycle. On March 23, Chesapeake Energy Corp. (NYSE:CHK) said it will further reduce its 2015 capital budget to $3.5 billion to $4 billion, a $500 million drop from previous guidance of $4 billion to $4.5 billion.

Chesapeake plans to operate 25-35 rigs in 2015, a 55% decrease from an average 64 rigs in 2014.

“In response to continued weak commodity prices, we are further reducing capital expenditures and associated drilling activity,” said Doug Lawler, Chesapeake’s CEO. “As a result, we now forecast ending 2015 with approximately $6 billion in combined cash and borrowing capacity under our credit facility. With this budget revision we anticipate being free cash flow-neutral by the end of 2015.”

The company also lowered its production to 635 Mboe/d to 645 Mboe/d, which is still an increase of 1% to 3% in volumes compared to 2014.

Comstock Resources Inc. (NYSE: CRK) also said March 23 that it will reduce 2015 capex by 22% to $248 million, a $69 million reduction from its December budget. Comstock said that improving drilling and completion (D&C) costs and the recent success of the company’s first Haynesville Shale refrack will allow it to release one operated rig drilling in the Haynesville at the end of March.

Wood Mackenzie said shale remains remarkably strong. The 35 remaining top oil-weighted sub-plays it examined need an average D&C cost reduction of 30% to be economic at $50 WTI. Wood Mackenzie said reductions of such magnitude are achievable and some companies have already announced them.

The most prolific sub-plays, including the Parshall Sanish in the Bakken and the Woodford in the Midcontinent, require less than 5% cost reductions.

“Experts have repeatedly underestimated unconventionals,” said Cody Rice, senior research analyst, Lower 48 upstream research, for Wood Mackenzie. “While low prices certainly hurt project economics, reports of the demise of unconventionals have been greatly exaggerated.”

Nevertheless, Saudi Arabia appears ready to go the distance in the oil price vortex it helped create.

‘Austerity on Steroids’

For years Saudi Arabia acted as though it wanted an oil boom.

Since last fall, by blocking an OPEC production cut and focusing solely on preserving market share, “Saudi has been telegraphing that it wants a bust—so there is a bust of epic proportions,” Molchanov said.

Saudi Arabia is the largest exporter of crude oil. Revenues from oil and petroleum products made up 89% of the country’s total revenue in 2014, according to the U.S. Energy Information Administration (EIA).

Saudi now seems set on an oil bust, EIA said. Saudi can withstand low oil prices for some time. In February, the EIA said the country’s 2015 budget was about $230 billion, but it expects to run a deficit, taking in $190.7 billion in revenue for a shortfall of $38.6 billion. Oil has since fallen from the high $60/bbl range to about $50/bbl.

Saudi can run at such deficits, or higher, since its massive sovereign wealth fund has banked at least $733 billion.

Although global upstream spending started to peak before last year’s oil price meltdown, the steepness of the 2015 capital spending curtailments is in a league of its own, Molchanov said.

Severe cutbacks have pushed global capex down 20% to 25% to the lowest level since 2010, Molchanov said.

U.S. spending is being curtailed at about double the global average, according to the Raymond James survey.

The spending cuts, what Molchanov calls “austerity on steroids" should ultimately result in a supply-led rebalancing of the global oil market.

In its survey, Raymond James found that not a single respondent company planned to increase spending in 2015. Molchanov projected an average spending cut of 20% t o25% worldwide. Statoil and YPF are cutting by less than 10%, while U.S. based Apache Corp. (NYSE: APC) cut its 2015 spending by 61%.

In the U.S., the rig count was down 41% year-over-year in mid-March, and mid-cap and small-cap operators with purely U.S. assets have generally cut their 2015 budgets by 35% to 60%, with a few down as much as 80%, Molchanov said.

For oil-weighted E&Ps such as Pioneer Natural Resources (NYSE: PXD) spending is down 45%, Denbury Resources (NYSE: DNR) down 46% and Oasis Petroleum (NYSE: OAS) down 51%.

Several gas-weighed E&Ps are also implementing sizable cuts, such as Antero Resources Corp. (NYSE: AR) down 41% and Range Resources (NYSE: RRC) down 45%.

More Pain, Less Gain

E&P capex deficits are unsustainable for the year, said Subash Chandra, analyst, Guggenheim.

“The capex deficit for our 17-company coverage universe is $4.6 billion in 2015, assuming a price deck of $57.50/17.25/3.35,” Chandra said. “At strip prices, the deficit widens by another 10% to 15%. We expect companies will have little choice but to further reduce activity levels, perhaps as soon as the second quarter.”

External financing for drilling activity could also remain elusive.

“In the fourth quarter, bank debt for our coverage universe totaled $8 billion while the working capital deficit, excluding derivative items, totaled $3.5 billion,” Chandra said. “Equity issues have been used to not just eliminate bank debt but also reduce the working capital deficit. We believe these capital raises have been misinterpreted as funding for the drillbit.”

The first quarter of 2015’s record equity financing is mostly tied to paying off bank debt and reducing working capital deficits, Chandra said.

While some companies have an ideal combination of few drilling commitments and a low capex deficiency, such as Cabot Oil & Gas (NYSE: COG) others such as Antero, Chesapeake, Continental Resources (NYSE: CLR) and Southwestern Energy Co. (NYSE: SWN) have more difficult decisions to make, Chandra said.

“Current guidance largely anticipates flat 4Q/4Q production levels,” he said. “The next sweep should guide for year-over-year production declines.”

Spending plans for 2015 at this point are still subject to adjustment in many cases, but critical factors will be the price oil prices at the end of 2015 and when 2016 budgets are decided, Molchanov said.

“But there is more pain to come before the next upcycle can sustainably emerge,” he said.

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