IPAA Economist Update Fall 2015

The IPAA hosted its Fall 2015 Supply & Demand meeting in Houston on Wednesday, Nov. 18th. The panelists featured the Committee Chair, Bob Fryklund with IHS; Mark Roche, Managing Director and Head of North American Oil & Gas for Credit Agricole Securities; and Angelica Jarvenpaa and Marnie Georges, both Research Associates from Raymond James. Bob talked about some of the key transitions occurring in the industry with the price downturn and the strategy shift evolving as various actors seek out the best and most efficient pathways to value. He also talked about relevant new actors such as big data, private equity and social activism that are impacting the industry roadmap going forward.

Mark Roche discussed several key changes that have taken place on the debt side of the E&P business including 1st lien RBL, second lien and high yield bonds. Currently, borrowers are in relatively fair shape after the fall borrowing base redeterminations and maturity schedules are stable with most RBL facilities maturing 2018-2019 and the bulk of high yield issues maturing in the 2020-2023 timeframe. However, banks are dealing with multiple exogenous forces including regulatory pressure pertaining to audits, exposure and the Shared National Credit (SNC) Review process which rates ‘survivability’ over loan structure. Increasingly, new hot buttons for the banks include high leverage, lack of leverage covenant and tight liquidity. In high yield, there has been a massive selloff with “70 as the new 90” and we are seeing frustration mount with the pursuit of second/third lien to enhance liquidity and pressure on companies either repurchase bonds or swap for equity. For the future, the spring borrowing base season could be more harmful as more hedges roll off (estimates of only 29 percent oil and 22 percent natural gas hedged in 2016 – Wells Fargo), cost reductions are maximized and leverage increases. As a result, banks will pull back and increase their financing costs. We can expect banks pulling back via loan sales and reduced new issue activity and an increased flow of institutional second lien issuance. There will be bond exchanges – cash pay exchanged for PIK notes, a more active secondary loan market as banks jettison loan assets to appease regulators, distressed funds picking up large blocks of high yield paper and finally, forced combinations/asset sales.

The Raymond James analysts focused on the current state of U.S. oil production and the related impact on global supply and demand. In terms of how the oil and gas world has changed they emphasized four points: 1) there is currently no excess oil capacity – for the first time in 40 years; 2) the U.S. has become a competitive oil and natural gas producer (most underestimate the U.S. efficiency gains, extraction cost is falling rapidly and U.S. oil supply is cheap, resilient and substantial); 3) the U.S. slowly displaces offshore/international; and 4) the shift has massive geopolitical considerations (stronger dollar, U.S. manufacturing wins, trade balances shift and global consumers win). For their price outlook, RJ sees average prices of $49 WTI in 2015, $55 in 2016 and a $70 average between 2017-2020 in their long-term forecast. Increasingly, emerging Asia (ex-China) and rest of world (Row) will drive oil demand going forward as China and North America slow from their rather robust 2015 pace. U.S. demand has grown over four percent YTD actual compared to the RJ estimate of three percent. The question remains who will fill excess demand as the world has been in a 20 year bear market for oil. U.S. oil growth has been staggering and looks to continue despite a momentary fall in 2016. E&Ps will continue to spend their cash flow and cap-ex looks to rise again after 2016 to levels approaching $100 billion. The rig count will be anemic in 2016 but will recover strongly into 2018. Without the Permian, drilling efficiency is up and there have been considerable productivity gains by play. Efficiency gains have even outpaced the RJ model with the highest production by rig by play in the Marcellus followed by the Eagle Ford, Bakken, Niobrara and Haynesville, followed by the Utica and lastly the Permian. U.S. oil productivity gains averaged 17 percent in 2014, 23 percent forecast in 2015 and 16 percent in 2016. Increasingly, RJ is focusing on the age of wells and their decline rate as well as the average age of a barrel in U.S. base oil production. RJ sees new oil production down 200,000 bbl/d from January 2015 to January 2016 but reduced declines in base production counteracts 100,000 bbl/d in lost new production. In their review of major play total production change, RJ sees a production bottom in September 2016. The steepest declines are behind us and RJ sees growth ahead in 2017-2018, especially in the Permian, Eagle Ford and Niobrara. RJ sees the rig count base dropping 48 percent in 2015 and 28 percent in 2017 before a 74 percent increase in 2017 and a 27 percent increase in 2018. They see U.S. oil production growth in their base case rising 595,000 bbl/d in 2015 before dropping 532,000 bbl/d in 2016 and then rising by 695,000 bbl/d in 2017. These trends impact their global oil model with a 600,000 bbl/d inventory build (year-over-year change) in 2015 followed by a 600,000 bbl/d drop in 2016, a 1.2 mmbl/d decline in 2017 and a 600,000 bbl/d drop in 2018. Risk factors to their model include storage capacity limitations, efficiency limitations and hyperbolic U.S. dollar risk on the bear side and accelerated non-U.S./non-OPEC supply declines in the near term and Middle East production risk on the bull side. In conclusion, U.S. production efficiencies are real and sustainable; U.S. rig activity looks to drop in 2016 and then surge in 2017-2018; despite U.S. oil growth, 2017-2018 is under-supplied; oil prices remain low in 2015/1H2016 but spike in 2H2016-2017.

Vice President of Economics and International Affairs Fred Lawrence spoke on an A&D Roundtable Discussion – The Private E&P Company Perspective at the Platt’s Oil and Gas Acquisition and Divestiture Outlook in Houston on Nov. 19-20. He was joined on the panel by Timothy Smith, President and CIO of Petro Lucrum, Inc., Ben Ellis, Chief Financial Officer of Travis Peak Resources LLC and moderator Jim Rice, Partner at Sidley Austin LLP. The conference focused on accessing liquidity, divesting assets, and assessing buyer/seller expectations in a new pricing environment. The Privaate Perspective panel looked more specifically at consolidation trends within the industry, the opportunity stack, buy-side interest as well as the evolution of the ‘value gap’ for both private and public companies. Speakers stressed conservatism and selectivity thus far on deals as the industry has not yet entered the more distressed ‘capitulation’ stage. Fewer assets are on the market, quality remains in focus and many projects remain overbid but patient buyers will continually look for proved developed value prospects with production/drillbit upside that competes favorable with internally-generated opportunities. Approximately $85 billion of private equity remains on the sidelines as the ‘value gap’ remains rather wide due to numerous market conditions and producer resiliency, helped by hedging, financing and less severe redeterminations in 2015.

The IPAA also wants to thank Jon Marsh Duesund of Rystad Energy for his insightful presentation at the IPAA Annual Meeting International Committee Pre-Reception on the macro environment and oil price trajectory. In addition, Mr. Duesund focused on the relative competitiveness of North American shale as break-even costs and prices have evolved. Over time with improved operator efficiencies, shale has been steadily moving to the left on the cost curve with higher cost frontier, oil sands, deepwater and heavy oil projects filling in on the right as the more marginal barrel in today’s evolving environment. Shale has continued to improve its overall competitiveness with OPEC conventional projects and thus market share has become a priority for all participants of the transforming global oil market. For more information on Rystad Energy’s analysis, please click on the following links:



A special thanks to our program speakers over the past few months and for the valuable insight and analysis provided to IPAA membership. If you are interested in getting more involved on IPAA’s Supply & Demand or International Committees, please do not hesitate to send Fred Lawrence an e-mail at flawrence@ipaa.org.