The Fuse

Price Rebound, Possible Turning Point Fail to Mask Industry Woes

by Matt Piotrowski | April 28, 2016

Bankruptcies, staff layoffs, capital expenditure cuts, and falling productivity continue to be commonplace during the downturn that has so far lasted for seven straight quarters.

The sharp rise in oil prices since February’s lows can’t mask the turbulence the oil and gas industry is still experiencing. Bankruptcies, staff layoffs, capital expenditure cuts, and falling productivity continue to be commonplace during the downturn that has so far lasted for seven straight quarters. The hope for the industry is that today’s price levels will hold and the current period will mark a turning point.

“Fundamentals are starting to move into balance,” said Patrick Pouyanne, the CEO of oil major Total, speaking at the Columbia Global Energy Summit in New York on Wednesday. He said the current rally is a mix of “market forces” and the “psychological effects” of both OPEC and non-OPEC producers starting to discuss managing supply levels—even though talks of a production freeze ultimately flopped in Doha. “By year end, we could see a rebalancing of the market between supply and demand.”

“By year end, we could see a rebalancing of the market between supply and demand.”

His company beat expectations for the first quarter, with a strong performance in its refining arm and an unexpected four percent rise in production offsetting weakness from low prices. Pouyanne struck a positive note about his company’s outlook, saying it will operate with more “flexibility” next year, further suggesting there has been an inflection point for both the industry and the market.

Oilfield services get whacked

Even if the industry has reached a turning point, the current environment remains stormy. Oilfield services companies have been hit particularly hard. Their customers, upstream producers, are reducing activity and spending, leading to lower demand for services that the sector provides. The rig count in the U.S. dropped another 27 percent during the January-March period, has continued to fall, and it is unclear when it will tick back up.

Halliburton had to slash another 6,000 jobs in the first quarter and has fired a third of its global staff since the start of the downturn.

“Life has changed in the energy industry, especially in North America,” said Halliburton CEO David Lesar last week. His colleague Jeff Miller, the company’s president, made a similar stark comment: “What we are experiencing today is far beyond headwinds; it is unsustainable.”

“What we are experiencing today is far beyond headwinds; it is unsustainable.”

Halliburton isn’t alone. Schlumberger, Halliburton’s peer, had to reduce its headcount by another 2,500 in the first quarter. So far this year, 12 North American oilfield services companies have gone bankrupt, with the largest being Paragon Offshore, which had total debt of $2.4 billion.

Because of the devastating effects in the oilfield services sector, it may be hard for U.S. production to rebound swiftly with higher price levels. Scott Sheffield, the CEO of independent Pioneer, said that production “can’t just jump back overnight.” Speaking at the Columbia event, Sheffield argued that oilfield services companies have lost so many employees that they will be understaffed to handle an uptick in activity.

More independents go bankrupt

Low oil prices continue to hurt all types of upstream producers, from majors to independents. Even Exxon Mobil, the biggest oil major and a company whose stock has risen 13 percent his year, has had its share of bad news. This week it was demoted from a top credit rating by Standard & Poor’s for first time since the Great Depression.

Many independents in the shale patch, meanwhile, are cracking. “There’s more debt in this downturn than I’ve ever seen,” said Sheffield, adding that there were “too many companies betting on $100 oil.”

There have already been at least 21 bankruptcies in the shale oil and gas patch this year.

The latest victims in the bankruptcy count among producers include Energy XXI and Goodrich Petroleum. There have already been at least 21 bankruptcies in the shale oil and gas patch this year. This comes on the heels of some 42 going under in 2015, according to the latest data from law firm Haynes and Boone. Analysts warn more are to come. Virtually all independents are at risk, but so far company pain has not led to a quick rebalance in supply and demand, since the bankruptcies are among firms with a total of only about 1 percent of U.S. production.

haynesandboone3

But it’s not quite all doom and gloom. Besides Total, other big companies such as BP and Statoil performed better than expected for the first quarter. Sheffield’s Pioneer is one of the few bright spots among independents, but even it has hit some bumps. For the first quarter, it reported a net loss of $267 million. Nonetheless, the company, which came under heavy criticism last year for its accumulated debt and was labelled “The Mother-Fracker,” saw its stock price rise this week because it is demonstrating growth, as a result of its stellar assets in the Permian Basin, at a time its peers are not. Pioneer sees its production growing by 12 percent versus previous estimates of 10 percent.

Hess Corp., one of the biggest independents with 355,000 bd, reported a loss of $509 million in the first quarter, $120 million higher than in the same period in 2015. Its capex totaled just $544 million in the quarter, down 56 percent year-on-year, in line with the industry trend. CEO John Hess said Wednesday in a statement it believes, despite the tough beginning to 2016, the company is well positioned as prices recover.

Rebalancing is happening slowly

All the cutbacks in drilling activity, staff, and capex have had an effect on production, but the pace of decline has been slower than anticipated.

But it’s still too soon to say the current rebound is sustainable. All the cutbacks in drilling activity, staff, and capex have had an effect on production, but the pace of decline has been slower than anticipated. In the past year, U.S. crude output has fallen by more than .7 mbd, or 7 percent. More is needed to bring the market into balance. The Energy Information Administration (EIA), for instance, says the global surplus sits at 2 mbd for the second quarter.

Sheffield argues more production losses are indeed in store, suggesting that U.S. production will only stabilize at $50—a price level he refers to as a “sweet spot”—and won’t grow again until prices are $60 or higher. In fact, the market hasn’t “seen the effect in production from the second rig count drop,” he said, referring to the lag impact from the precipitous decline to current levels of 343 rigs after stabilizing last summer at just under 700.

Pioneer’s Sheffield argues more production losses are indeed in store, suggesting that U.S. production will only stabilize at $50—a price level he refers to as a “sweet spot”—and won’t grow again until prices are $60 or higher.

While the fundamental outlook is slowly making its way toward rebalancing, the conventional wisdom is touting a tighter market at the end of this year, as Pouyanne forecasted, and higher prices in 2017 and beyond, as capex cuts bite and production falls. As a result of capex cuts, in 3-4 years, there will be a “lack of supply,” said Pouyanne.

In the meantime, however, the “lower-for-longer” thesis hasn’t fully cracked yet. The recent price spike has led to a wave of hedging among U.S. independents, a sign production may continue falling at a snail’s pace. Companies that have hedged well, including Pioneer, have been able to protect their budgets. Sheffield confirmed that hedging activity has picked up. “People are hedging more and more in the marketplace, and will look to hedge more,” he said, noting that too many producers went for too long without locking in prices, bringing about the large amount of debt.

hedgeswsj

OPEC, meanwhile, has shown no signs that it can come to an agreement to manage the market to shore up prices. Goldman Sachs and others see the cartel raising its output this year and next. The rebalancing is also highly dependent upon strong oil demand growth. Economic headwinds are challenging that. Even if the rally is sustainable and first quarter turns out to be a turning point, the repercussions of weaker prices for almost two years will continue to take their toll. More pain for the industry is still in store.

ADD A COMMENT