The Fuse

Earnings Show Small Cracks in U.S. Oil Industry

by Matt Piotrowski | August 02, 2017

  • U.S. E&Ps announce almost $1 billion in capex cuts
  • U.S. E&P stocks decline sharper than oil price in 2017
  • ExxonMobil has lost money in U.S. drilling for 10 straight quarters
  • EOG grows volumes by 25 percent in Q2

Things are not going according to earlier expectations in the U.S. oil and gas sector. The price bump at the end of last year and a strong Q1 brought about renewed enthusiasm and expectations. But a range-bound market has tempered expectations. The industry is not on the verge of falling apart as it was in early 2016, but current price levels are having negative effects on production and companies’ balance sheets.

Based on earnings reports, a number of narratives are beginning to emerge which may portend increasing tightness in the U.S. oil market. E&P companies have reported production levels lower than expected and cut capital expenditures while forecasts for U.S. crude oil output are more sober.

The smaller independent players are struggling to hit targets at current price levels and the majors are focusing on becoming more efficient. The majors are reporting higher profits, which shows progress in cost cutting and strong downstream profits. At the same time, though, they are putting forth a renewed sense of caution and restraint. As a group, U.S. E&Ps have seen their stock value drop by more than 21 percent through the end of July, a larger decline than the fall in oil prices. And it stands in stark contrast to the S&P 500 rising by almost 12 percent in 2017.

Despite positive signs for most majors, there are still plenty of reasons for consternation. ExxonMobil, for instance, has lost money in its U.S. drilling for 10 straight quarters, and its production globally has contracted for five straight. The Dallas-based oil major said it had spent slightly more than $8 billion the first half of the year, which is not on pace to meet its initial annual target of $22 billion. Chevron, meanwhile, has bucked the trend of lower-than-expected output that many others are experiencing, but its impressive growth in volumes has stemmed in large part from its Gorgon LNG project in Australia—although its assets in the Permian are attractive to investors. Outside the U.S., Statoil said it is slashing spending by $200 million and BP saw its profits fall. Goldman Sachs, in a research note, said that for Q2, Big Oil—including major European companies—capex came in 3 percent less than expected.

Independents struggle

U.S. independent producers are by no means homogenous but they are all having to deal with similar headaches at current price levels.

U.S. independent producers are by no means homogenous but they are all having to deal with similar headaches at current price levels. Anadarko, which is set to cut its capex by $300 million this year, revised its 2017 production guidance downward after it shut-in wells in Colorado and reduced production due to divestitures. Bakken-focused Whiting Petroleum slashed its capex by $150 million and reported lower-than-expected revenues for the quarter. Hess, another Bakken producer, also cut spending, and investors are not satisfied that its production growth is coming more from gas than crude oil. For the quarter, it reported a loss of close to a half billion. The struggles of these two companies reflect how the Bakken, which used to be the hottest shale play, has lost some of its luster as production there has stagnated and more companies are enthralled with the Permian instead.

capexcuts

But not all is well in the Permian either. Pioneer Natural Resources saw its production grow in the quarter by 10 percent but also faced a number of delays and said it is reducing spending plans for 2017. The shale-focused company is cutting capex by $100 million as it defers 30 completions in one Permian play until next year. Its stock price fell sharply after it reported earnings this week and it is down by more than 19 percent this year.

Pioneer is cutting capex by $100 million as it defers 30 completions in one Permian play until next year.

Sanchez Energy, another independent, though smaller in size, said it will cut its spending by $75 million-$100 million in 2018. The company was forced to lower its production estimates because of poor operations at a number of wells and cut its number of rigs to 5 from 8. Although the company is relatively small, it is one of the top three leaseholders in the Eagle Ford and has acquired assets from Shell and Anadarko.

EOG is one company that bucked the trend. It grew second quarter total crude oil volumes 25 percent to 334,700 b/d, setting a company production record, and is not planning to slash capex for the year, keeping it around $4 billion. Despite the good news from EOG, its stock still fell after it announced its latest round of earnings late Tuesday because results came in lower than expectations.

Besides lowering capex and missing output targets, producers aren’t as active with their hedges with prices under $50. One energy investor told The Fuse that companies added only a small amount of hedges during the last quarter, when WTI averaged $48.15 per barrel. And most of the hedges that were added were for 2017 rather than 2018. This means that as a group, the industry will be “under-hedged” heading into next year, leaving companies more vulnerable to any price declines. That could, of course, change should a price rally take place. “If prices get back to $55, you know shale producers will hedge as much as they can. They need to lock in production,” one trader told The Fuse.

Why current trends matter

What do the results mean for the oil market? Fundamentals are tightening due to lower-than-expected production—along with OPEC cuts and robust demand—and the outlook could fundamentally change further down the road if capex cuts continue, although the exact tipping point is anyone’s guess. Over the past five weeks, U.S. crude stocks fell by about 800,000 barrels per day. Meanwhile, the EIA has revised its forecast for U.S. production for 2018 downward by 100,000 b/d in its latest monthly outlook. Total U.S. crude oil production averaged 9.17 mbd in May, according to the latest revised monthly figures. That is more than 300,000 b/d higher than year-ago levels, but 150,000 b/d below preliminary estimates for the month, reflecting how output isn’t growing as sharply as originally thought.

Fundamentals are tightening due to lower-than-expected production—along with OPEC cuts and robust demand—and the outlook could fundamentally change further down the road if capex cuts continue.

Critically, analysts are re-evaluating their outlooks for companies after the Q2 earnings, particularly since the price outlook is less sanguine for the industry. For their investors, companies will have to clearly show that they can generate cash and grow production in a relatively low price environment. Given the uncertainty around the global oil market—which stems from a variety of issues including OPEC’s strategy, Venezuela’s upheaval, and lower capex—long-term supply growth will likely continue to take hits.

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