Wunderlich Securities analysts expect oil and gas exploration and production companies to further reduce spending in 2016 as the industry tries to position for recovery. A summary of the 2016 oil and gas exploration and production industry outlook follows.
A year has lapsed since Saudi Arabia decided to produce all out and regain market share, in turn, slashing oil prices. We still believe that the market will re-balance, but it will take longer than anticipated. For the US, we expect significant CapEx cuts for 2016, once producers come up with spending plans for the year, which means we could see another drop in the rig count in late 2015/early 2016.
However, the US is only a part of the total puzzle. Elevated international inventories and fears of strong Iranian exports continue to put downward pressure on the market. Following last week's OPEC meeting, it looks like not much is changing, whether in terms of pricing or production. However, we believe that US production will come in 2016 due to lower CapEx spend. We have updated our survey of capex budget estimates for 71 independent E&Ps and 10 large integrated players. Since our last survey in late September, CapEx estimates have fallen by $17.1 billion. With many companies still waiting to provide guidance, we believe CapEx will go down further from here, in turn leading to lower production as well.
- US resource plays are not the only villains contributing to the oil glut. While US resource plays are often blamed for the glut, a number of long lead time, highly complex conventional projects overseas and in the US deep water Gulf of Mexico have also contributed. Like it or not, we have to deal with these new fields. Eventually the incremental growth will be offset by older declining fields, but that will take time. Hence, while we think the market will eventually balance out, but it is likely to be at a glacial pace. That said, the significant reduction of spending in the near term could lead to a shift from an oversupply to an under-supply of oil as fields decline and new investment wanes (currently $200 billion in projects is estimated to have already been pulled due to low prices).
- The Saudis still hold the key to reducing crude oil surpluses quickly. The Saudi’s scorched earth strategy has flooded the market, depressed oil prices, and created a free-for-all in the oil market. While not rational, in our view, that is how it has played out and continues to move forward. In a simplistic sense, four countries can impact the oil surplus meaningfully: the US, Russia, Iran, and Saudi Arabia. We are optimistic that US production will decline in 2016. We expect Russia to stay flat and Iran to try and restore production to pre-sanction levels. This leaves the Saudis as the only producer left capable of reducing production meaningfully to soak up the surplus in a short period to balance the market (and thus theoretically stabilize and improve oil prices).
- US E&Ps could reduce CapEx by 29% in 2016. Since our last survey in late September, both 2015 and 2016 CapEx estimates have come down. Largely as a result of efficiency gains, 2015 estimates have decreased another 2% for independent E&Ps in our survey, or ~$2 billion. For 2016, 42 of the 71 surveyed companies have provided some form of guidance, but even this guidance is mostly informal. Of the E&Ps with guidance, the average CapEx budget is set to decline by 29% in 2016, a bigger decline than the 23% seen in our last survey. We expect more severe cuts to be announced in the next few months given the continued difficulties in the market. For a sense of scale, in 2015, spending declined on average by 48% compared to 2014 for this group.
- Integrated and international players skim a little CapEx off the top. Since our September survey, 10 large integrated companies surveyed have slightly adjusted 2015 CapEx, reducing it by ~$1.5 billion, or 0.5%. The large players were among the first to provide clearer guidance on 2016 and beyond. On average, their budgets should decline by 10% next year, a decline from 8% in our last survey, or an additional $7.7 billion lower. In 2015, on average, the integrated companies in our survey cut spending by 9% from 2014.
- Consensus CapEx estimates continue to lag behind more clearly guided budget plans. In our last survey, analyst consensus estimates showed E&Ps without guidance decreasing CapEx by only 2% in 2016. As we pointed out in September, this seemed overly optimistic and far behind the 23% average CapEx decline suggested by E&Ps providing more detailed guidance. The consensus is now catching up as it estimates an average 12% CapEx decline in 2016. Nonetheless, this is still below the 29% average CapEx cut guided by names providing some form of clearer guidance. We expect to see more CapEx cuts and look for associated production declines.
- US natural gas production is still growing. The EIA's latest data indicates that the U.S. produced ~76 bcf/d in September 2015, a 4 bcf/d increase over September 2014, or ~5.5%. In addition, associated gas from oily plays such as the Eagle Ford and Permian have a big role in boosting production. With rig counts declining in these oily trends, we hope associated gas production could flatten out in 2016. The demand side of natural gas is becoming more interesting despite the mild winter as more Mexico exports and LNG exports impact 2016. Industrial use is mixed as steel plant utilization remains weak while some other sectors benefit from the low prices.
- Implications for the E&P Group – stability, safety, and patience. As the picture remains unclear and changing, the macro is not rewarding those who act too early. We expect consolidation, restructurings, defaults, and bankruptcies to pick up speed as private producers and weak public producers run out of time and options.