An influential investor said the oil crash in progress is not as bad as it was in 2014 for investor-owned oil companies. It is worse.
That judgement was offered by Dan Pickering, founder and chief investment officer of Pickering Energy Partners, who pointed out that this time, cash-strapped producers do not have a financial safety net.
“In 2016, Wall Street and energy private equity rescued distressed energy companies. That won’t happen in 2020 or 2021. With the energy sector as the worst S&P subsector of the past year and past decade, investors are once bitten, twice shy … This is a very bad time to be an outcast,” said Pickering. He described this as the riskiest environment he has seen in his 35-year career.
Analysts from Wood Mackenzie agreed quick action is required by weaker companies, but after years of cutting costs, there is little chance they can make money if prices remain well below $50/bbl.
In late trading Monday, Brent remained below $35/bbl and West Texas Intermediate below $31/bbl, on a day when a stock market rout raised more general concerns about future economic growth.
The price collapse could be the trigger for a new phase of deep industry restructuring—one that rivals the changes seen in the late 1990s,” Tom Ellacott, senior vice president for corporate research, upstream at Wood Mackenzie.
He agreed that shale producers who borrowed to grow will be on the leading edge of this change: “Indebted Lower 48 producers could be forced to act sooner rather than later.”
One of the independent oil companies Pickering said should take immediate action, did so Monday morning.
Diamondback Energy announced it would immediately cut the number of crews completing wells from nine to six. It will also reduce its drilling rigs working by two now and will drop a third one in April. Parsley Energy followed by reducing the number of frac spreads completing wells from five to three. It will reduce the number of drilling rigs working by three, to 12, “as soon as is practicable.”
Both operators predicted that these emergency cuts, plus profits from barrels hedged on financial markets, will allow them to continue to earn profits even at depressed prices.
“While this decision is expected to result in lower 2020 oil production than originally forecast, we will maintain positive cash flow and protect our balance sheet and dividend; these are the conditions that Diamondback is prepared for,” said Travis Stice, chief executive officer for Diamondback.
Owners of drilling rigs and frac spreads were already struggling with falling demand, and the combination of global COVID-19 and the OPEC price war is likely to make it worse.
Matt Gallagher, president and CEO of Parsley, said they “remain committed to doing whatever is necessary to protect our balance sheet in the weeks and months ahead."
What’s Next?
Most oil companies did not immediately react to the price collapse. Pickering’s note written before the price crash on Monday said, “In the face of the current low $40s oil, slowing upstream capital spending will result in reduced supply, but it could take 6–18 months. The oil market does not have the luxury of 6–18 months. It needs fewer barrels fast.”
He predicted falling prices. “Oil traders have the playbook from 2014–2016, so things will happen faster than they did then. Computer-driven trading will likely exacerbate trading movements. The downside today is no different than 2015–2016. High $20s, low $30s.”
One thing that has changed is that investors are not likely to again pump $30 billion into distressed companies with what looked like rich assets back in 2014, which reduced the number of bankruptcies after that crash. Pickering said “Any company growing production in 2020 should ramp down capital spending immediately. This means you, Exxon, Chevron, EOG Resources, and Diamondback Energy (to name just a few).”
But for companies with heavy debts, large dividend obligations, or breakeven prices over $50/bbl, the only cure is higher oil prices. If Brent remains around $35/bbl for the rest of the year, Wood Mackenzie estimated it will remove $380 million in cash flow from the earnings forecasts, according to data in its proprietary database. That would be 80% less than if that benchmark had remained at $60/bbl.
“Sustained prices below $40/bbl would trigger a new wave of brutal cost cutting. Discretionary spend would be slashed, including buybacks and exploration,” said Fraser McKay, head of upstream analysis for Wood Mackenzie, who predicted cost-cutting moves will be “necessarily fast.”
During the last downturn, companies demanded and received deep discounts from suppliers, who have been slashing capacity in money-losing businesses, such as pressure pumping. And it will be hard to drill horizontal wells any faster.
“There is much less obvious excess spend to cut this time around after five years of disciplined investment and austerity,” Ellacot said. Possible spending reductions include delaying conventional project sanctions and infill drilling or reducing maintenance.
Companies are also likely to reduce drilling and completions activity, which will mean layoffs for the crews on those jobs, which could trigger more service company layoffs if this slump lingers. Companies are more deliberate when it comes to managers, engineers, and other exploration and production professionals, but they are not immune to it.
If this lingers for 6 months or more, the Houston area could lose 14,000 jobs, adding to 5,000 losses expected before things got worse, according to Bill Gilmer, an economist with the University of Houston, who made that prediction in an interview with the Houston Chronicle before Monday’s crash.
Normally job-cutting takes time. “Oil employment moves very slowly in Houston. For the whole process to work out, it takes” a year or more, Gilmer said.
Decision makers are trying to figure out how this unique, virus-driven crisis plays out. When the International Energy Agency (IEA) recently predicted that oil demand will drop this year, it offered three scenarios to cover the wide range of production possibilities.
Its base case assumed China’s outbreak will be under control by the end of the month, and that containment measures in North America, Europe, and elsewhere will have less impact on oil demand than China, with its huge energy-intensive manufacturing sector. That scenario assumes oil demand begins rising during the second half of the year for a drop of only 90,000 B/D for the year. Its pessimistic estimate is for slower recovery in China and around the world, reducing demand by 730,000 B/D.
Growth remains a possibility. The IEA said that would require China to quickly control the outbreak, and “the most serious contagion remains limited to a few countries, with no serious impact in most of Europe and North America.” In that case, oil demand would rise about 480,000 B/D.
