Moody’s sees no quick supply response to spending cuts

Spending cuts announced so far by oil and gas companies will have a limited effect on oil supplies in a year beginning with oil price weakness and promising trouble for the producing and support industries, says a report from Moody’s Investors Service.

If the price of West Texas Intermediate crude oil recovers to an average $75/bbl for 2015, writes Moody’s Senior Vice-Pres. Pete Speer, the North American exploration and production industry’s capital spending would drop by 20% below the 2014 level.

“But if oil prices remain below $60[/bbl],” he adds, “companies will make more drastic cuts, reducing capital spending by 30-40%.”

Outside North America, spending will decline by 10-20%, depending on oil prices, according to Speer.

The Moody’s analysis assumes prices of $75/bbl for WTI crude this year and $80/bbl in 2016 and after, with a “stress” assumption of $60/bbl. Its assumptions for Brent crude are $80/bbl this year and $85/bbl next year and after, with a stress level of $60/bbl.

Its assumptions for the natural gas price at Henry Hub are $3.75/Mcf on average this year, within a range of $3.50-4.50/Mcf, rising to $4/Mcf next year. The stress gas price is $2.50/Mcf.

The analysis assumes NGL prices of $28/bbl this year and $30/bbl next year and after. The stress NGL price is $20/bbl.

Slow supply response

Moody’s Senior Vice-Pres. Terry Marshall says, “We see no near-term catalysts that would change the supply-demand equation” now depressing crude oil values.

Marshall says the analysis emphasizes stress-level prices for oil and the base-level gas price. Moody’s expects oil prices eventually to return to about $80/bbl as demand increases and supply responds to capital-spending reductions by producers.

“But this supply response will not be meaningful until the second half of 2015 at the earliest and quite likely not until 2016,” Marshall says.

The credit-rating firm expects another round of capital spending cuts if current oil prices persist into the first quarter.

“Further reductions would have a moderate downward impact on 2015 industry-wide production levels and will lead to production curtailments at producers with high sustaining capital [investment needed to keep production at current levels] and have a much more-pronounced impact on 2016 industry-wide production levels,” Marshall says.

Pressure on services

As E&P companies cut capital spending they’ll seek rate cuts for land drilling and oil-field services (OFS), Speer notes.

Oil prices averaging $75/bbl this year would reduce OFS earnings by 12-17%, he estimates. Prices below $60/bbl would lower overall earnings before interest, taxes, depreciation, and amortization by 25-30%.

Sajjad Alam, Moody’s assistant vice-president and analyst, says 2015 will be “the toughest year for offshore contract drillers since 2009” as “a tidal wave of new rig deliveries” hits the market amid slumping oil prices.

Next year could be worse for offshore contractors, Alam says, “because many of the existing rigs, particularly jack ups, will have to renew contracts in 2015 at significantly lower rates, and companies will have less backlog and financial flexibility than in 2014.”

Operators have been trimming offshore spending since the middle of 2013, first to boost returns and more recently to preserve capital as oil prices fall, Alam notes, adding the waning demand “compounds the offshore rig industry’s overcapacity problem.”

Alam expects upstream spending offshore to contract by 10-15% this year with $60-70/bbl oil.

Integrated companies

Major integrated oil companies, says Moody’s Senior Vice-Pres. Tom Coleman, “have been more measured in their response to the drop in oil prices than E&P and OFS companies, which are more directly exposed to commodity price risk.”

Before the price collapse, major companies were focusing on capital discipline, portfolio optimization, cost reduction, and raising shareholder rewards, Coleman points out. Those moves responded to pressures from cost inflation and project delays and were manifest in capital spending reductions, slower decisions on new projects, increased dividends, and share repurchases.

Moody’s expects major companies to make further capital cuts, delays in investment decisions, staff and cost reductions, and other efforts aimed at efficiency.

According to Coleman, “A number of activities are at risk of reduction or elimination, including wildcat exploration, alternative energy, pre-FID (final investment decision) projects at early stages, mature field and high-cost enhanced oil recovery projects, new long-cycle investments in the Canadian oil sands and deep water, nascent unconventional shale plays in new locals, and expensive LNG projects, particularly as buyers look at rising LNG supplies and customers resist oil-linked pricing.”

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