OPEC may not be able to inflict enough pain to derail US shale

After listening to several of the conference calls and skimming several transcripts (CHK, EOG, RRC, WLL, CLR, APA, MRO, PXD) so far I think there are a number of broad take-aways from the US focused E&P sector.

1) The bigger companies like APA, PXD, MRO are predicting flatish growth this year, with some quarter over quarter declines towards year end.  These companies tend to be spending about within cash flow, meaning that they don't need new financing to fund their capex program.

2) Other companies like WLL, RCC, CHK are running negative cash flow but still growing at quite a rapid pace in some cases (not CHK).

3) In many cases the companies say they are waiting for either service costs to come down OR oil prices to go up.  They don't need both to happen to increase activity levels, even at the current strip.

Overall, if prices don't go down further it looks like the E&Ps  have avoided any real 1980s style bloodbath.  Smaller service companies and offshore drillers may still see some bankruptcies or recapitalizations.  A few of E&Ps also may still go bust.  Energy XXI, Tullow (international), Bill Barrett Corp, ZAZA, Swift, Sandridge and several others are trading like they might go under.  None of these are companies that I'm particularly familiar with.

I also will again point out that we will see massive efficiency gains this year in the US unconventional producers.  This will be due to operational improvements, technological improvements, and service price declines.  If oil gets back to $70 a year from now, that may be as profitable for the on-shore unconventional producers as $90 WTI was a year ago, as has been noted in some of the calls.  The most at-risk projects may be the offshore, where we have seen consistent cost growth in recent years, as tight oil sees cost per barrel produced decline.  Remember that tight oil is still only about 7 years old, and still seeing dramatic improvements.  Deepwater has been around for decades now, and the easy gains in efficiency are probably behind us.  So deepwater and tight oil may have similar breakevens right now, but who will have the advantage 5 years from now?  The answer to that question seems fairly obvious.   Ultradeepwater may be more at risk of being the victim of the current price environment than the unconventional on-shore producers.  This is one of the reasons why I'm not really looking at the deepwater drill ship operators like RIG and ESV.  The other main source of high cost oil, oil-sands, seems also to be surviving without too much trauma.

If this is as bad as it gets, has OPEC simply lost its nerve?  Was their goal only to put a bit of the fear of god into the western E&P companies?  Because if their goal was to derail US shale, $50 oil for 6 months is not enough.  It may be that the Saudis either don't have the stomach or don't have the ability to drive the price down to where it would need to go to truly cause distress to the US producers.  I remain on the sidelines, with inventories continuing to build every day, but I must admit that I am starting to find myself looking at companies to buy rather than thinking about who would be the best short.

EOG earnings call- Joins other large-caps in guiding to flat 2015 production

EOG (formerly Enron Oil and Gas), has the well deserved reputation as the premier operator among on-shore US E&P companies.  There are certainly other companies that fall into the “premium” category, like Range Resources and Cabot in gas, or Pioneer and Noble in oil, but EOG is definitely the first among equals.  They had a bit of an earnings miss.  Here are some take-aways.

• EOG deferring many well completions to wait for higher prices and lower service costs.  200 wells waiting on completion now, and there will be 285 at year end.
• Capex goes from $7.5b in 2014 to $5b in 2015.  Capex more focused on infrastructure than last year.
• Flat production yoy for 2014 to 2015.  If they are getting $65/bbl at year end they will ramp back up but stay within cashflow.  They can get double-digit growth at $65 again next year.
• “Flat to negative US production growth on a month over month basis by the end of this year” industry wide.
• 10-30% cost reductions in services so far.
• Hoping for 10% reduction in total well costs this year.
• Decline rate is slowing over time.  Partly this is due to a maturing production base (older wells comprising a larger part of production than previously).  Completion technology is also starting to flatten out decline rates.  Seeing lower long term decline rates in the higher density fracs.
• They have a lot of their own sand etc, so they might get a bit less on cost reductions than others, since they are starting from lower.
• With today’s technology improvements, they are seeing the same returns at $65 oil as they were seeing with $95 oil in 2012.

Regional info

Cutting back in the Bakken and Eagleford, ramping up from a low base in Permian as results improves.  All other plays will have limited activity.

• Eagleford 345 wells this year vs 534 in 2014 year.  Running 15 rigs.
• Bakken 25 wells this year vs 59 last year with 3 rigs.
• Leonard Shale (Permian)- 23 wells this year vs 18 last year. 
• Bone Springs (Permian- 37 wells this year vs 3 last year.
• Wolfcamp (Permian)- 26 wells this year vs 19 last year.
• Cutting back a lot on any drilling outside of the big three.

Highlights from Pioneer and Apache conference calls last week

I skimmed the transcripts and there were a number of interesting bits.  The main takeaways were

1. These guys are doing BIG capex reductions, which I think is an appropriate move.
2. The current price environment certainly does not pose an existential risk to the North American focused large-cap E&Ps
3. They are slowing down drilling waiting for service costs to come down, and not just waiting for oil prices to go up.  They might ramp drilling back up if they can get the anticipated price reductions for services, especially related to pressure pumping.

APACHE:

• Massive capex cuts were announced.  Apache is going from 91 rigs in Q3 2014 down to 27 rigs.  They are guiding to flat production.
• $3.8b 2015 capex guidance is a 60% cut vs 2014.
• Wells that cost $8mm each in 2014, they were projecting $7mm for 2015.  Now they say maybe down to $6mm with anticipated service cost declines.  And there are plenty of wells that can deliver “solid economics” at the current strip price.
•  What they are waiting for is not necessarily a rise in oil prices, but rather a decline in service costs, which will make drilling more economic.  They are even deferring completions to wait for price declines in services.  They anticipate turning more rigs on at the end of the year, EVEN IF THE PRICE STAYS FLAT AT CURRENT LEVELS.
• 20% service cost declines they think is quite a conservative number.

Apache has not been a well run company.  I owned it for a while through September of last year because of the very low valuation, not because of any particular confidence in management. 

They also had “pro forma growth” of 12% yoy at 609 mboed.  This is always funny that someone can use the word “growth” with a straight face when their production actually declined by about 20%.  Apache sold stakes in over-budget LNG projects in Australia for $2.75b (pending).  They continue to spend money on this, which they will be reimbursed for at closing, for an additional $1b.  They sold stakes in Lucious and Heidleberg projects in deepwater Gulf of Mexico for $1.4b in announced in June.  They sold western Canada Assets for $375mm in March.  They sold their stake in Argentina to YPF announced in March as well for $850mm.  They end with $10.5b in net debt.  A year prior they had about 7.6b of net debt.  So assuming they get the $3.75b cash for the LNG projects (the extra $1b is for capex incurred since the deal was signed), which are not contributing to production, their net debt has declined slightly and their production has declined from 761mboed per day at year end 2013 down to 609 mboed at year end 2014.  They have returned cash to shareholders with the dividend and share buybacks.  401mm shares outsanding in YE 2013, and 24 million were bought back over the course of the year ($150mm at $60 per share).  $100mm was also spent on dividends.  All told though, Apache has not made good investment decisions.  We have seen net debt fall slightly (maybe $500mm) as production falls dramatically, even in a year of generally high oil prices.

I must say though, that I approve the massive capex cut strategy and it is certainly good news is they are not talking about selling their cash cow Egypt assets, which some have urged.  

PIONEER

• Full year 2014 production was up 18% yoy to 182 mboed.   Currently production is at 201 mboed for q4.  Oil production grew at 25%.  Projecting average 2015 production to be up 10% on 2014, but with qoq declines near the end of they year.
• 2015 capex guidance of 1.85b, 45% below 2014.
• Reducing rig count 50% to 16 rigs in Spraberry (Permian basin) and Eagleford.  They are shutting down all vertical rigs.
• Assuming $9mm for a 9,000 ft horizontal well in the wolfcamp for 2015, but he says that is quite conservative and it might end up being lower.  This would give them 55% irrs at the strip pricing.  This is benefiting from a 20% service cost reduction plus improving well performance.
• They say they can get similar returns at $70 as they were getting at $90 if the anticipated cost reductions come through.

I think they are taking the correct actions in the current environment.  I still think they are overvalued with a $23b market cap.

Iraq and Iran- other reasons to worry about oversupply

Its easy to be overly focused on North America because of the detailed disclosures, and because that is where the major production growth has been over the past few years.  But Iraq has been a huge source of production growth over the recent months.  Historically they have fluctuated between 1 and 3 million barrels per day over past decades, depending on wars and insurgencies etc.  Last December they reported that they produced a record 4 million per day.  The Iraqi oil ministry has previously stated that they have the intent to produce 9 million a day within a decade!  There is no doubt that they have the fields to do it, it is just a question of stability, attractive fiscal terms, and political will.  Although ISIS has periodically threatened supplies, production has actually been growing in the ISIS era.  Also, recent agreements between Kurdistan and the central government have allowed Kurdish oil in the north to flow more freely, and this is also indicative of further increases in production going forward.

Iran has also been an under performer ever since the fall of the shah.  In recent years production has declined to 3 million per day, partly because of the sanctions.  If a nuclear deal were reached production could potentially go up dramatically.  It could even double.  Who knows how likely this is.  But if you hear "nuclear deal has been reached" this is definitely long-term bearish for oil prices.

On the other side of the ledger, I think there is some risk that Russia, the world's largest producer, could see declines due to sanctions, especially if we get stepped-up sanctions due to further deterioration of the Ukraine situation.  In fact it was a collapse in Russian production that softened the 1980s glut, after the economic collapse of the Soviet Union.  Another possibility is that Russia cooperates with OPEC to prop up prices.  In the past the Russians have said that because their industry is in private hands they have no way to cut production.  No one believes that.  Certainly Putin could tell them to cut production, and they would do it.  It makes sense for Russia to cooperate with OPEC.

Drilling productivity and a look at year over year production numbers

Region	New oil production per rig YOY	Total Production YOY growth
Eagleford	23%	32%
Bakken	26%	31%
Permian	11%	28%
Niobrara	28%	23%
Utica	74%	14%

The new EIA drilling productivity report came out yesterday.  There was no real change in trend.  Efficiency gains continue at about the former pace, as does production growth in the key regions.  We have seen no obvious effects yet from the capex cuts.  The rate of growth of the big three unconventional oil plays (Eagleford, Bakken, Permian) clearly will have to slow down at some point.  But currently we are seeing no signs of production flattening out, let alone declining.

In percentage terms the rate of growth in Bakken and Eagleford is indeed slowing: for instance in calendar year 2013 production in the Eagleford grew at about 46%. vs 32% this year.  But this is just because there is a higher total production.  The rate of growth in terms of barrels per day of production was higher in 2014 at about 450,000 b/d growth in crude production, vs 391,000 b/d growth in 2013 for the Eagleford.  Total production is now 1,715,000 B/D making it a top 5 oil field in the world.

Bakken grew production by 314,000 b/d in 2014 vs 198,000 b/d growth in 2013.  Total production is now about 1,300,000 b/d.

The rate of production growth in the Permian has actually been accelerating since oil started to drop.  It grew by 420,000 b/d in 2014, compared to only 202,000 b/d of production growth in 2013.  Total production is 1,962,000 b/d.

I also want to not once again that rig productivity is increasing at a very steady pace.  In the Utica, the 74% increase is off a very low base, so it isn't as impressive as it might seem.  Whenever you hear someone say, "you need $60 oil to make money drilling in the bakken", it may lead you to think about the economics of drilling in overly simplistic terms.  For one the "breakeven" point is a moving target that is always moving lower due to the rapid efficiency gains.  Secondly, service cost increases or decreases can further distort this number.  And finally, it is important to keep in mind that economics vary wildly from one area within the region to another.  I believe that rig productivity numbers may soon start to increase at an even faster pace as inefficient operators and those with poor quality acreage shut down their rigs first.  One anectdote is the report yesterday from Pioneer Resources, a Permian and Eagleford focused E&P.  They intend to cut capex by 45% but they are still planning to grow oil production in 2015 by 20%.   I know of no companies that are projecting declines in North American oil production this year (the oil majors are in perpetual production decline, but this is mostly from overseas).  If the goal of OPEC/Saudi Arabia is to balance the market, then we are still going to have to wait.  We are not seeing signs of production declines from the major high cost producer (us).  

just cut my whiting position in half today at 36.95 after the big rally over the past few days

Of the several mistakes I've made, not selling Whiting when I sold FCX, APA, CVX, CHK in July-September period was the biggest mistake.  Another mistake was buying EOG in September, but at least I got out of that in December with only a 3% loss or so.

I have almost no money in E&Ps now, so I'm certainly anticipating another leg down.  

Anadarko Petroleum Conference call, commentary on service costs

Anadarko is one of the largest US based exploration and production companies had their conference call today.  They are a deepwater exploration specialist, but also have considerable on-shore US assets in the Wattenberg (Colorado, oil), North East Marcellus (Pennsylvania, dry gas), and Permian Basin.

I skimmed the transcript and didn't see anything to earth shattering.  There was an interesting comment on service costs:

"Okay, I will start with this and I will see if I can get Chuck Meloy to also to give you a few thoughts from him. If you think about the fact that onshore today, unlike say ten years ago, around 70% of our costs are now in completions, whereas 10 years ago 70% of the costs were in actual drilling of the wells, and 30% were in completions. As a result, as we’ve looked at this and comments I made in January at a conference would concur with and get ready to tell you that simply we don’t see this being a quick change to the service cost environment simply because we are going to honor our contracts and I think so will the industry.

We are in this with the service companies as partners. As we move to sync up those costs however I think you can anticipate that maybe by the end of the year, early into the next we could see significant reduction in service calls. If we were fortunate enough to be able to find a [indiscernible] to save 20% reductions in service calls and you think about it being in a prior world at $90 per barrel and the economics they gave us at the well head, $70 could be the new $90 or $90 could be the new $70, however you want to look at it."

The implication here is that service costs may not have the scope to drop to the degree seen in prior busts because of the make up of those costs.  I don't really understand why completion costs are less flexible than drilling costs, but if this is true then I will have to temper my expectations for cost reductions.   Actual declines in service costs are only one area where E&Ps can increase drilling efficiency.  It is important to remember that drilling efficiency had been increasing steadily prior to the oil price declines without cost concessions from service providers.

oil up over 10% in past few days, I'm not buying the rally

When waiting for a tremendous bargain, as oil stocks go down and down, there is a big temptation to buy when we get an up move for fear of missing the opportunity.  I don't think we are there yet.  Capitalism works because a decline in prices sends a signal to producers to produce less.  There is a saying in the world of commodities: "the cure for high prices is high prices".  And of course the corollary of this is that the cure for low prices is low prices.  I do think that we are now below the long run average price that oil needs to be at to spur sufficient production to meet world demand.  But I don't think we are as far below that price as some seem to think, and certainly oil does not have to be at $90 per barrel or higher.   We have  too much production for world demand now.  In the USA, one of the highest cost producers, where you would expect to see the biggest declines after a price correction, we have seen big capex cuts.  But not a single producer has signaled that their production will decline.  In fact, monthly data from EIA continues to show production increases, and we haven't even started to see the rate of increase slow (the 2nd derivative of oil production, if you like).

Rig count cuts and capex cuts are not enough to solve the short term problem.  BUT they may be enough to convince the Saudis to try to boost the prices a bit towards $70 or so.  If they think that their actions have had the desired effect of reducing long term supply in the USA and other high cost areas, then perhaps they will try to create the conditions for a price rise. They are still talking down the price for now.   I don't think we are there yet, and I'm not buying.

A few bits from the Hess, Oxy, and Conoco conference calls last week

I scanned through these three conference calls from the past week.

Hess:

Cutting 2015 capex to $4.7b from 5.6b in 2014.  45% of which is unconventional on-shore US and the rest is offshore US and international.

Greg Hill, President and COO, stated: “We are reducing our 2015 spending in the Bakken to $1.8 billion, compared with $2.2 billion in 2014. In 2015, we plan to operate an average of 9.5 rigs and bring approximately 210 new operated wells online, compared with 17 rigs and 238 operated wells brought online in 2014.

“In the Utica, we plan to spend $290 million compared with approximately $500 million last year, as we transition to early development at a measured pace in this price environment and as infrastructure builds out. Over 2015 our joint venture with CONSOL intends to execute a two rig program focused in the core of the wet gas window and bring 25-30 new wells online, compared with four rigs and 39 new wells in 2014.

In their supplemental info they also show how well costs are down to $7.1mm from the quarter, down from $8.6mm in Q1 2013.  They expect to get cost reductions from suppliers.   800-900 mboed for IP30s- 175,000 mboed is their target for the bakken eventually.  So they are cutting the rig count by half and yet expect to drill only 12% fewer wells compared to last year in the bakken.  They also say they can keep production at least flat with this reduced rig count.  As I've said many times, there is unlikely to be a steep drop off in production in the US unless there is a much steeper sell off.

Also their cost reduction projections are quite modest.  They are more or less predicting that the current trend in cost reductions will persist.  I think this is incredibly conservative, and I believe cost reductions will accelerate rather significantly.  While these companies have been pursuing efficiencies by streamlining operations before, they will benefit in the year ahead from declines in service costs, and the almost complete elimination of drilling single-well pads to hold acreage by production.

The HES transcript was from seekingalpha.com.

Conoco Phillips

transcript:  http://www.conocophillips.com/investor-relations/Pages/default.aspx

Formerly the smallest of the majors, COP is now the biggest E&P after spinning off its refining unit Phillips66.  They are illustrative of what is wrong with the major companies.  They spent $17.1b in capex last year vs. 15,800 in cash flow from operations.  And with that out-spend in a very high priced environment they managed to only replace 97% of reserves, and grew production by 4%.  I haven’t looked to see if they did the old trick of replacing oil production with cheaper gas production and claiming to be replacing reserves and maintaining production.

They are planning to run 6 rigs in the Eagleford, 3 in the Bakken, and 4 in the Permian basin.“We are in the sweet spot of the Bakken. With the rig rates and the rates that we are getting, it's economic at current conditions, but we're actually taking it all the way down to three rigs this year. We do have some commitments within some of the units in the Bakken where we have to run some rigs in the Bakken. The Eagle Ford is still very economic, even at current prices. But having said that, it makes more economic sense to defer. So what we're dealing with in the Eagle Ford is a balance of -- we have some commitments. We need to run probably three rigs to meet commitments on our leasehold. And we're also keen to continue to learn on the Eagle Ford because we have a huge inventory there that we could develop over the next couple of decades. And we want to make sure that we're capturing all the learnings.”
 In response to another question:
“Well, Guy, I think you are really trying to focus in on the unconventionals in our portfolio. So to give you a sense of that, we expect our production from the Eagle Ford and Bakken will grow from about 200,000 barrels a day in 2014 to about 225,000 barrels a day in 2015. So somewhere between a 10% and a 15% increase. Now, that production growth is all going to come through the first half of the year. And then if we stay at the rig counts that we said just now, we're going into a slow decline in both the Bakken and the Eagle Ford, not a rapid decline but a slow decline. And that's going to continue into early 2016.”

So we are seeing some projections of declines at COP for domestic US production.  This is really the first time I'm seeing an E&P admit that their US production will decline, and they seem to indicate a peak production in mid-late 2015.  Although we should note, that they are still projecting higher domestic US production for year end 2015 compared to today.

Occidental Petroleum

These guys are the second largest US E&P after COP.  They replaced 174% of reserves in 2014.  They have a rock solid balance sheet with a net cash position.  Production was flat at 591,000 boed for 2014.  From an unconventional standpoint, they are mainly concentrating on the Permian, where their biggest unconventional acreage is.  They are seeing 750 mboe type-curves in the Wolfcamp, and 900 mboe in the Spraberry.  No big takeaways for me from this conference call, except that they are cutting capex from $8.9b in 2014 to 5.7b in 2015, and that they continue to see significant improvements in the Permian.