With second-quarter earnings season for oil and gas companies looming, analysts weighed in on expected themes. Permeating their forecasts was frustration with operators’ determination to keep drilling despite lagging oil prices and oversupply concerns.

James Wicklund of Credit Suisse noted in a mid-July report that “there is little question that the current stock prices (for oilfield services) are discounting a decline in activity, spending, revenue growth, margins—whatever the category is.”

While drilling is up markedly—the horizontal rig count by 70% on average year-over-year, according to Wicklund—E&P companies aren’t adjusting budgets.

“At the strip, we estimate the E&P industry will have to outspend cash flows by 60% to keep spending flat in 2018, putting the average debt ratio for the industry at 2.9x by year-end 2017,” he said.

Analysts are taking E&P companies to task for not reducing production given the U.S. role as swing producer.

“The oil price goes low enough until the industry finally decides to ‘do the right thing,’” Wicklund said. “But no one wants to go first.”

Cowen analysts led by Charles Robertson II put forward a similar outlook.

“We don’t see E&Ps cutting to levels required to rebalance in 2018,” they said in a mid-July report. “Our view for a recovery in 2019/2020 remains unchanged from the start of the year.” Investors’ behavior suggests they think crude prices will need to be at or below $40 for operators to drop rigs.

Gabriele Sorbara at Williams Capital Group said he expected E&Ps to emphasize their “flexibility to position defensively and preserve capital should prices erode further. Despite the reduced cash flow levels at current strip prices, we expect our companies to stick to their current plans with sensitivities/color on how they are initially framing up 2018.”

Major themes will be derisking additional zones and downspacing in the Permian and Stack/Scoop, and enhanced/optimized completion designs across all the resource plays, according to the Williams Capital report.

Excessive capital spending and weak oil prices have made Mizuho Securities USA LLC’s Timothy Rezvan equally cautious on the E&P group. Like other analysts, he would like to see “rational growth/efficiency targets achievable within discretionary cash flow become more pervasive goals amid a ‘lower for even longer’ world.”

He further noted that resilient U.S. production growth is exacerbating OPEC growth and keeping markets oversupplied. Nevertheless, he doesn’t expect to see operators curtail production because many prefer lower leverage to lower absolute debt.

Rezvan called operators’ arguments justifying free cash flow deficits “increasingly hollow.” He disputed the rationales frequently put forward by producers: the need to keep spending to reduce leverage, which he said could lead to “negative outcomes without a medium-term price rally”; the benefits of drillbit efficiencies, which he said could be managed better with a lower spending program and fewer rigs; and the claim that free cash flow neutrality is one to two years away, “so the outspend is temporary.” Rezvan said that this “carrot” is “one of the most often used (and least frequently obeyed) claims offered by upstream management teams.”

Nor is he swayed by the argument that ongoing work brings value forward and increase net asset value: “pulling barrels forward into a sub-$50 WTI world does not appear to be value-accretive,” he said.

Comments