Higher upstream budgets and more spending, particularly in the Permian, by E&P companies are evident this year, according to analysts that track U.S. onshore oil and gas activity.
Barclays reported in a note this week that preliminary upstream budgets of the top 40 U.S. onshore producers it surveyed show spending up by 9%, slightly lower than the Street expectations ranging from 10% to 15%. This comes as oilfield service (OFS) companies follow through on forewarned cost increases to regain some of the financial ground lost during the market downturn.
“While the E&P operators rightfully state that break-even costs have come down significantly over the past couple of years, there is an impending cost inflation avalanche coming from the service industry, which continues to operate at unsustainable pricing levels,” Schlumberger CEO Paal Kibsgaard said during the Scotia Howard Weil Energy Conference in March 2017. “This inflation will ultimately end up in the financial results of the E&P operators.”
The oilfield services sector was hit especially hard during the downturn as players worked to maintain their share of the business, working with cash-strapped oil and gas companies seeking discounts.
Cost inflation “will eat into purchase power” such as activity levels with “some E&Ps indicating upwards of 15%, in part to OFS companies just recouping their own cost inflation,” Barclays said in the note updating its E&P spending survey. “Our survey shows E&Ps increasing Permian spending by 19% compared to relatively flat in other oil basins, which suggests slower sequential growth in completion activity for the remainder of the year in U.S. land, putting estimates at risk, particularly for those outside the Permian.”
U.S. financial services firm Cowen & Co. said nearly 90% of the 65 E&Ps it tracks have indicated in guidance an 11% planned hike in overall capital spending, anticipating higher commodity prices, according to a Reuters report. Oil prices have been steadily rising with a barrel of West Texas Intermediate (WTI) trading for roughly $66.82 at 12:30 CT April 12. It was just more than $53/bbl a year ago.
Cowen said E&Ps that have reported 2018 capital plans anticipate spending $80.5 billion total this year compared to about $72.4 billion in 2017.
Many aim to spend within cash flow while generating returns.
EOG Resources Inc. (NYSE: EOG), for example, has said the company expects its total capex to range from about $5.4 billion to $5.8 billion in 2018 with capital going mainly to areas with the highest potential rate of returns in the Delaware Basin, Eagle Ford, Rockies, Woodford and the Bakken. This is up from between $3.7 billion to $4.1 billion last year.
Occidental Petroleum Corp. (NYSE: OXY) said earlier this year that it set a 2018 capital budget of $3.9 billion with estimated production growth of between 8% and 12%, with 40% annual growth in Permian resources.
E&Ps are scheduled to start releasing first-quarter 2018 earnings results later this month, likely also providing updates on field developments and capital programs.
Looking specifically at U.S. onshore upstream spending, Barclays said there is “potential for upward budget revisions likely tempered by widening Permian differentials and return of capital programs.” But factors such as lingering Permian differentials, takeaway capacity, buyback and dividend programs and oilfield inflation could block increased spending, the analyst added.
Cost inflation was also brought up during Chevron Corp.’s (NYSE: CVX) analyst day in March. Deutsche Bank analyst Ryan Todd pointed out that cost inflation has been seen in the past six to 12 months in the Permian. He wanted to know what the company was doing to mitigate rising costs.
Chevron CEO Mike Wirth said the company has “seen a little bit of pressure” in the Permian, but that is not the case in other parts of the world where “we’re still finding globally that we can hold or even further reduce costs across all the different lines of procurement activity that we have,” according to a Seeking Alpha transcript of the meeting.
Jay Johnson, executive vice president for Chevron’s upstream operations, added that the goal is to remain competitive in the Permian, which is one part of the company’s global operations. To cope with Permian inflation the company uses indexed pricing in some contracts and working to put contracts in place well in advance to lock in needed equipment and services among other efforts.
“Largely, the mitigation is going to be pretty effective in the near-term but over longer periods of time then we may see that costs move up,” Johnson said.
Barclays said U.S. onshore 2018 budgets released in March show “the delicate balance E&Ps face in improving returns without sacrificing production growth.”
“With most budgets set at $50-$55/bbl WTI, capital discipline is showing in large-cap E&P spending at about 100% of their discretionary cash flow and SMID caps keeping to only about 105%, which is well below the five-year average of about 118% and 155%, respectively,” Barclays said. “E&Ps have a long history of outspending [including the last three years], but a behavioral shift may be in store since investor demands for higher returns really hit a fever pitch last September.”
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