Wood Mackenzie lists 15 things to watch for in North America's upstream sector in 2015.
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The drop in oil prices has led to an unprecedented level of uncertainty going into 2015, especially for the prospects of the North American upstream oil and gas sector. While there is a lack of consensus about when oil prices will stabilize and at what level, Wood Mackenzie expects service cost relief, asset high-grading, and efficiency improvements in operations.
"We are already seeing this play out as upstream operators announce drastically reduced capital budgets for 2015, yet forecast increased production growth (in aggregate)," says Delia Morris, senior North American upstream analyst for Wood Mackenzie. " As long as operators can move to the core areas of plays and sub-play breakevens continue to fall with the drop in service costs, producers will keep chugging along until funding dries up."
The following are the key themes identified by our analysts for 2015, primarily focused on the upstream sector, but including notes on the prospects for North American LNG, NGL markets, and US policy around Keystone XL and the U.S. crude export ban.
- Upstream costs are the silver lining for operators: As companies have decreased capital budgets, we are seeing a slowdown in drilling activity. This reversal is already having an impact on the demand for rigs, pressure pumping fleets, and other key equipment and services. If the oil price were to average around $50/bbl in 2015, we anticipate a 40% decline in the horizontal rig count compared to 2014. Rig day rates could fall by 30% or more.
- Refracs start to look better than new fracs: Over the past year, lower US natural gas prices drove Marcellus operators to shift attention to horizontal refracs in order to increase recovery rates at reduced costs (~25% lower expenses for a standard well). Successful refrac testing also took hold in gas-rich plays like the Haynesville and Barnett where some operators were able to re-set production rates to early life profiles and, in some cases, increase performance.
- Haynesville – dry gas is back!: Crude market realities will drive service costs down in 2015 and this improves the return of dry gas investment, which will be competing for capital in an environment with fewer economically attractive options. According to our latest Haynesville Key Play update, the Greenwood-Waskom, Spider, and Woodardville sub-plays have gas price breakevens of $3.46/mcf, $3.31/mcf, and $3.37/mcf, respectively.
- Eagle Ford remains the cream of the crop: Lower oil prices will lead top operators to drive down drilling and completion costs. Our North American Supply Chain Analysis Tool (NASCAT) predicts that costs in the Eagle Ford will come down an average of 20% for drilling, and 10% for completions. This will lead to lower WTI breakevens in the core of the play, which, for many operators, means economic drilling well below $50/bbl.
- Permian M&A will heat up in H2: Deal flow was very strong in the Permian during 2014, with over $15 billion worth of transactions. We expect the M&A market to cool down as we move into 2015 and anticipate less than $2 billion in H1 2015, rising to about $10 billion in H2 2015, when oil prices should pick up. With a lower oil price environment expected during the first half of the year, there could be possible consolidation or the dissolution of smaller operators that are not well-hedged and are financed by high-yield debt.
- U.S. Gulf of Mexico activity will defy low oil prices: Despite lower oil prices, Wood Mackenzie estimates that GoM drilling activity will increase by more than 30% year-over-year in 2015, as development drilling ramps up, rig contracting continues, and operators fight the clock on lease expirations.
- Operators ease off the gas in Canadian unconventionals…: We anticipate a sharp drop-off in Western Canadian drilling levels due to lower oil prices and our outlook for a widening AECO basis. Liquids-rich areas, such as the Duverney, Montney, Falher/Wilrich and Glauconite will see lower activity levels, but to a lesser extent than in other plays. The expanding commerciality of intervals in the Deep Basin and drilling in newer niche plays like the Torquay in Saskatchewan will continue, but at a reduced pace.
- …and hit the brakes in the Canadian oil sands: As many as 16 oil sands project phases that have not received corporate sanctioning are at risk of being deferred if current low oil prices persist. At the same time, the low oil price environment could warm up a deal market that has been markedly quiet over the past two years. Large acreage holders like Sunshine Oilsands could turn into bargain investment opportunities for companies seeking long-term resource potential and betting on a long-term oil price recovery.
- North American LNG loses some luster, but maintains momentum: We expect that only six U.S. projects with total capacity of around 60 mmtpa will be under construction in 2015. Four are already being built (Sabine Pass LNG, Cameron LNG, Freeport LNG, and Cove Point LNG), while two other facilities (Corpus Christi and Elba Island) will begin construction in 2015. We also anticipate FID at Canada's Pacific North West LNG in 2015, in tandem with further upstream investments in the Montney.
- Ethane is maxed out: The US ethane market has become chronically oversupplied and now requires maximum rejection, fuel demand to replace natural gas, and exports to balance. Maximum ethane rejection has resulted in many natural gas pipelines reaching their maximum BTU limits as ethane is kept in the gas stream since it is more valuable as a fuel than as a chemical feedstock. We expect ethane to continue to trade at a $0.50-$1.00/mmbtu discount to natural gas for the foreseeable future.
- 2014 outages are a structural feature of the chemicals market, rather than random variation: Spot ethylene margins have recently decreased from $0.60/lb to $0.30/lb, and are expected to remain under pressure in 2015 as supply outstrips demand. During 2015, Wood Mackenzie forecasts producer margins to shift from the ethylene cracker back to the polyethylene unit. We also expect polypropylene margins to improve. The biggest factor to watch during 2015 is how the industry runs its plants; can they finally overcome all of the unplanned outages and run at reasonable rates? If not, the US petrochemical industry could continue to experience a supply constrained market for a fourth year in a row.
- Keystone XL remains in a holding pattern: It appears that the political will is not aligned to see the passage of legislation approving the Keystone XL pipeline, which would deliver 830,000 b/d of crude from Canada to the Gulf Coast. President Obama has signaled that he would exercise his veto power over any Keystone XL bill that attempts to short-circuit the ongoing State Department review. With this lingering threat, plus recent Democratic amendments aimed at scuttling a Republican-led Senate bill to gain support for the pipeline, chances look dim for the approval of the pipeline in 2015 via legislation.
- The MLP boom still has a bit of room to run: The MLP sector took a major hit in 2014, commensurate with the fall in commodity prices. E&P-focused MLPs, like LINN Energy and Breitburn Energy Partners, were especially vulnerable to the drastic shift in the oil price. Most energy-focused MLPs are related to infrastructure assets, however, and are not as sensitive to the rise or fall of commodity prices. Even if there is a supply response in tight oil in 2015, we think there is scope for growth in MLPs related to the storage or transport of oil and gas.
- U.S. Crude export policy – evolution rather than revolution: In June 2014, Enterprise Energy Partners and Pioneer Natural Resources received private rulings from the U.S. Commerce Department clarifying what constitutes sufficient distillation, thereby paving the way for condensate exports. Subsequent foreign-marketed cargoes signalled that it was possible to export hydrocarbons meeting this criterion. We saw further constructive evidence that crude export policy could be loosening through the U.S. Government issuance of new guidelines in December 2014, allowing for more streamlined and efficient ways to export condensate cargoes. Although we do not believe that the ban will be lifted wholesale for all classes of crude oils in 2015, expect to see an increase in condensate exports as the industry tests and clarifies the definition of distilled condensate.
- The benefits of Mexico's opening will accrue mainly to larger players: The fall in oil prices will result in less speculative interest by smaller and newly established companies in Round One. Overall, interest will likely focus on discovered fields rather than exploratory blocks, with the exception of Perdido. Joint ventures will allow for cost and risk diversification in the current price environment. Finally, there will be a reduced interest in natural gas, unconventionals, and heavy oil blocks, all as a result of the lower price environment.
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