Musings: E&P Spending Survey Gives Cheer Not Lumps Of Coal
The annual exploration and production spending outlook survey conducted by Barclays oilfield service stock research team was unveiled a couple of weeks ago. According to the analysts, global oil and gas companies plan on boosting their E&P spending by 7 percent to a record $644 billion in 2013. That's the good news. The bad news is that almost all the growth in spending will be outside of North America, where the spending outlook is projected to be flat with 2012. The analytical team at Barclays has been conducting these spending surveys for many years, and the results are anxiously awaited by the industry to see the thinking of managements about future oil and gas prices, commodity demand and where and how much the oil and gas companies figure they can, and should, spend to find, develop and produce hydrocarbons.
The capital spending increase for 2013 would mark the fourth consecutive year of growth, although the amount of the annual increases has varied noticeably. The Barclays' analysts believe, as well as energy company managements, the industry is in the early stage of an extended demand cycle, which will be driven by growth in developing economies. That growth should spur higher oil and gas prices providing producers with additional cash flow that is expected to be spent finding and developing future production. Reading the chart that we have reproduced in Exhibit 2, Barclays expects global capital spending to grow by almost 55 percent between 2011 and 2016, or at a healthy double-digit growth rate. The chart also shows that the spending growth will be driven by higher international spending.
Ever the optimistic bunch, in response to the fact that the anticipated spending growth derived from the survey results fell short of the historical average spending growth since 2000, the Barclays analysts made the following observation about the survey: "While our survey has been directionally accurate over time, it also tends to prove conservative relative to actual spending levels." This statement accompanied a chart showing the annual spending forecast and the resulting actual outcome for 2000 to 2012. They pointed out that there has only been one year in that period when actual capital spending fell short of the forecast, which occurred in 2010. However, it is likely that spending in 2012 may also fall slightly short of the beginning year estimate.
The key to the Barclays' analysts' optimism about spending in 2013 is the relationship between the forecast for oil and gas prices used in budgeting by the companies and those of the bank's commodity experts. In the case of crude oil, there is substantial upside to the estimate companies are budgeting. The companies have an average forecast price of $85 per barrel, while the Barclays commodity group sees prices averaging $115. What this means is that if global oil prices hit the Barclays forecasted average, there will be substantially more money available for E&P spending. The Barclays estimate is well above the $101 per barrel figure managements have said is the point at which they would upscale their budgets.
Offsetting the positive cash flow implications of higher oil prices is the possibility that natural gas prices could meet Barclays' expectations that are about 7 percent below the operator average forecast, but this shortfall would mostly hurt the pace of spending in North America. Barclays has an average price expectation of $3.25 per thousand cubic feet of gas versus the industry average price expectation of $3.47. If Barclays' estimate proves more accurate, industry cash flow would be hurt, which might force producers of dry natural gas to have to reduce their E&P spending. The key to how much a company's cash flow might be impacted depends on its mix of gas and liquids production – more liquids production at a higher price helps offset the lower cash flow from weaker natural gas prices. There is also the issue of the mix of hydrocarbon targets in the lease inventories of companies. If a lease is already held by production, then throttling back spending wouldn't have too much impact on a company's future. On the other hand, producers might be forced to give up expiring leases if they didn't believe gas prices would recover soon enough to justify the cost of drilling a well to hold the lease, which would impact the future value of a company. This is a phenomenon that is starting to happen in the southern region of New York State as its moratorium on fracturing wells has prevented any shale drilling on leases that are due to expire in 2013.
The mix of E&P spending in 2013 will provide a challenge for the oilfield service industry. As shown in Exhibit 6, the forecast calls for spending in 2013 to barely move the needle in Canada and the U.S. In fact, the only potential for additional activity is the impact that lower service costs might have on company economics coupled with improvements in drilling and completion efficiency that enables more wells to be drilled per rig.
Outside of North America, there are a number of geographic regions that are forecasted to show double-digit spending growth – Latin America; India, Asia & Australia; Middle East; and FSU/CIS. It is also noteworthy that the supermajor oil companies are targeting a healthy spending increase (8.9 percent) next year, which helps offset the projected decline in international spending by North American independents (-5.2 percent). In summary, it looks as if 2013 will be a mixed year for the petroleum business as the economic and hydrocarbon situation in North America limits industry growth. At the same time, the growth of developing economies around the world will drive energy consumption up, thus stimulating international petroleum industry activity. Increasingly, the outlook for the global energy industry will be dependent on the pace of economic activity that is being challenged by the economic, financial and political challenges virtually everywhere in the world. Let's hope the New Year brings better results than currently anticipated.
G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.
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