S&P Global published report titled “Industry Top Trend 2017” which indicates that rating trends across the energy sector continue to stabilise. The sub-sectors with the highest percentage of negative outlooks primarily are oilfield services and offshore contract drilling. The tremendous number of downgrades and bankruptcies we saw over the past two years will not likely be repeated.

S&P Global indicates that credit ratios for many upstream companies are improving materially owing to the rebound in hydrocarbon prices. Going forward, it is expected that credit ratios to improve nominally as volumes and oilfield-service (OFS) prices increase and more cost efficiencies are achieved upstream.

Hydrocarbon price decks for oil and natural gas are flat owing largely to relatively flat futures curves and reduced production costs.

S&P Global expects that capital expenditures (capex) to begin increasing along with an increase in OFS costs of about 10% in 2017, led by North America.

It is also expected that offshore drilling to remain weak and still vulnerable to additional new supply entering the market. Gasoline demand will likely increase modestly with a more robust response in distillate. There could also be some modest improvement in overall industry crack spreads.

I noticed that despite predicted 10% cost increase and modest increase in petroleum products, S&P Global highlights material improvement in upstream credit ratio and expects and expects credit ratios to improve nominally.

Since I am not an expert in credit rating, I cannot argue with experts who drafted this report. Nevertheless, I really want to understand how S&P Global made this “modest” optimistic conclusion regarding credit ratios. Therefore, let’s consider facts.

Following a painful war with OPEC, U.S. oil output is poised to rebound this year, thanks to healthier prices and a strengthened business model.

 

That could set the stage for America to set a record-breaking 2018, taking out the all-time oil production high set in 1970, according to new forecasts published this week by the U.S. Energy Information Administration.

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“We believe shale production is set to reestablish itself for growth” that could be “fairly dramatic,” said Anthony Starkey, energy analysis manager at Bentek Energy, a division of Platts.

According to CNN Money, all of this oil flowing out of Texas and other shale regions could throw a wrench in OPEC’s plans to bring the oversupplied oil markets into balance and the cartel’s ability to negotiate more production cuts later this year.

The EIA also cited changes to its forecasting model that better account for how U.S. rigs have become vastly more efficient.

Those efficiency gains have been critical. Lower prices, better technology and improved balance sheets have allowed U.S. shale companies to do more with less.

The impact of the rising flow of US LNG exports has been closely tracked by the market. The increase in exports of crude oil and NGLs produced from shale has drawn less attention, but it may have even more important consequences.

US prod and export

According to the Oil Price, things could get even worse in light of recent oil price developments that suggest the OPEC deal may not have the desired effect.

Following OPEC’s decision on production cuts of 1.2 MMb/d, Russia, Kazakhstan, and Azerbaijan all confirmed they are cutting production in line with their obligations under the deal with several Middle Eastern producers, including Saudi Arabia and Kuwait.

However, the increased U.S. production is likely to offset efforts of OPEC and Non-OPEC producers on production cuts in order to push prices closer to $60.

US crude exports exceeded 1 million barrels per day (MMb/d) in the first few weeks of 2017 as the country’s production recovered to 9 MMb/d – having dropped by more than 1 MMb/d from highs of 9.6 MMb/d reached last year.

Rapid Improvement in Efficiency 

For years Saudi Arabia had been the undisputed world leader in the oil market. However, thanks to advances in shale drilling technology, oil production in the U.S. recovered from years of declines, and at one point America overtook Saudi Arabia as the world’s largest producer. In fact, shale drillers pumped out so much oil that the world became vastly oversupplied, which caused prices to crash. The Saudis didn’t help matters, choosing to leverage their low costs into higher volumes to drive as many shale producers out of the market as it could.

Ironically, the choice of Saudi Arabia forced shale producers to become much more efficient, which led to a significant reduction in costs.

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Producers are cashing in on a more stable oil market, with prices swinging between $50 and $55/bbl. “U.S. rig counts should rise further, with the Permian leading major basins,” Bloomberg Intelligence analysts Andrew Cosgrove and William Foiles wrote in a note Monday. While a 30%-40% increase in spending will drive rig gains, they wrote, “these could be weighted to the first half as oil-price volatility surfaces midyear, around the end of the OPEC cut window.”

OIL SERVIVE

Rystad Energy estimates that up to $15 billion in increased spending will flow into the non-OPEC shale market in 2017 following OPEC’s decision to cut production. 

Non-OPEC shale well services are best positioned with an estimated $10 billion of additional spending, followed by drilling contractors with $2.5 billion, assuming 10,000 wells are to be drilled and completed.

“2016 has been an even tougher year than the previous for most service companies, and revenue reductions range from 30% to 50% for onshore North American service companies. 

Rystad Energy analysis also shows that offshore suppliers will continue to struggle, with the overall offshore market to be reduced by $19 billion in 2017 as compared to 2016. EPCI and subsea purchases are most impacted with more than $12 billion and $4 billion of reduced spending, respectively.

Although implementation of new technology significantly reduced costs, the US producers are still far behind. It appears that Saudi Arabia remains at the top of the game.

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It is important to keep in mind that impressive cost reduction indicate average number. It does not apply evenly on the entire basin.

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All-in costs for exploration and production companies include things like general and administrative overhead and interest charges, all of which must be borne by the barrels they produce. In addition, transportation costs can vary widely depending on where you’re drilling, where your refining customers are and whether the oil is being shipped by pipeline, rail-car or truck.

Bloomberg indicates that a driller in the Bakken with an average breakeven price of $52 a barrel would need to add about $4 for overhead and interest charges and assume the oil is being sent from North Dakota to refiners on the Gulf Coast by railroad at $12 a barrel. The all-in breakeven price for that barrel is $68. If there’s space on a pipeline available, then that comes down to maybe $63.

In contrast, drillers in the Wolfcamp basin — part of the prolific Permian basin — enjoy average breakeven prices of about $42 to $43 a barrel on Wood Mackenzie’s projections. Add in $4 of overhead and interest but only $3 to ship the oil across Texas, and the all-in breakeven price is about $50. 

Even if suffering oilfield-services contractors demand higher fees and help raise those breakeven prices some, OPEC’s room to maneuver in using supply cuts to push prices higher has shrunk significantly.

The short time that it takes to develop shale resources, relative to conventional oilfields, and the E&P industry’s ability to raise money on the back of promises of growth mean that pushing the price too high could unleash another round of fighting for market share, just as we’ve seen these past two years.

Drilled but Uncompleted Wells (DUC)

DUCs located across the U.S. shale patch. Over the past two years the oil and gas industry drilled thousands of wells that they ultimately decided not to complete, leaving a large pool of oil that is sitting on the sidelines waiting to get into the game. Deferring completion made sense when oil prices were plunging to lows not seen in years – why not wait until oil prices rebound to extract your oil and put it on the market?

For much of the past two years during the oil price downturn, the DUCs began building up, but data was scarce. In September, the EIA began publishing figures on DUCs. All told, there are an estimated 5,069 DUCs in the seven major shale regions tracked by the EIA. The Permian and the Eagle Ford have the most, with 1,378 and 1,276 DUCs, respectively.

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DUC

Supply/Demand

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Forecast suggests that soon we can reach Supply vs Demand Balance. However, the ability of the US producers to quickly react on slightest improvement of the oil price by increasing production, dose not support such forecast.

McKinsey & Company issued a report “BEYOND THE SUPERCYCLE: HOW TECHNOLOGY IS RESHAPING RESOURCES” whereby it highlights the striking characteristics of the down phase of the super-cycle was the unravelling of what had been a close correlation between the markets for coal, copper, iron ore, and other commodities and those for oil and gas.

While these markets rose in unison, seemingly as a monolithic group, during the upswing, divergences in supply and demand fundamentals for each commodity have meant that the correlation no longer holds. It is expected that this divergence to continue over the next 20 years, with ongoing shifts in demand and supply for oil, natural gas, thermal coal, iron ore, and copper, as well as for niche resources such as lithium and rare earth metals.

demand growth

It appears that projected crude oil demand remains relatively flat.

cost of renewables

Cost competitiveness of renewables is in opposition of the view that the recovery of oil prices is going to take place soon.

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According to Trading Economics, price of WTI would start declining in Q3 2017. Whereby Brent is estimated to stay above $50 until 2020. If, besides the above, we would take into account Brexit, a wide range of uncertainties and rising political tensions worldwide as a result of Trump’s policies, impact of climate change and accelerated technological development that would soon make renewables cost competitive, this forecast appears reasonable.

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Financial Health of Major Oil Companies.

I would conclude that fundamentals suggest that instead of anticipated improvement we shall expect slight decline in oil prices. Therefore, to understand optimism of S&P Global it is important to look at financial strength of the selected major oil companies.

EXXON MOBIL

XOMIS

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Royal Dutch Shell Plc 

SIS

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SRFH

Total SA

TF

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BPInSt

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BPRFH

CHEVRON

CVIS

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ConocoPhillips 

copis

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As we can see, the numbers do not support optimism which was stipulated in S&P Global report. All of these top oil and gas players demonstrate deteriorating financial health. Irrespective of other numbers, it is difficult not to notice that these companies have either insufficient or negative cash flow.

It is also not possible to miss that the numbers suggest a widening gap between total liabilities and net income. I am sure that it is not required to be an expert to understand where it will lead considering the the low crude oil prices are here to stay.

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With greater flexibility of the U.S. shale producers, the oil prices are likely to remain low for quite some time. Increasing oil and gas activities would lead to escalation of costs. Donald Trump’s “America First” aimed to boost national economy as well as policy of isolationism and deregulation are have potential to contribute to the cost increase.

Federal Reserve intention to hike interest rates multiple times could lead to the unsustainable level of debt. If oil prices would remain suppressed, major oil companies might not be able to survive.

Default of majors will force banks to write off huge sums of money creating favourable conditions for banking crises and mass unemployment.

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