A weekly look at what occurred in the oil markets of the U.S. and the world this past week and what’s ahead.
The same week that a major Wall Street company put out a report noting that U.S. companies are going to be more disciplined and less focused on rising output for the sake of rising output, U.S. output of crude oil hit an all-time high.
Well, we think it did. And actually, it was the week before last. The number – 12.5 million barrels per day (b/d) – came in the weekly report of the Energy Information Administration (EIA), a set of data that market participants watch like a hawk for its numbers on inventories but whose production levels are usually taken with a grain of salt.
It’s not that everyone thinks they’re incorrect. But they are preliminary and the monthly numbers that are reported with a two-month lag are seen as being more accurate. (Some state-by-state reports are considered even more accurate on that granular level.)
Still, the EIA number can’t be ignored. Clearly, there was data and other indicators that led the EIA to post that 12.5 million b/d number, 200,000 b/d more than the prior week and 300,000 b/d more than a month ago.
But two days before that number hit the markets, Bank of America Merrill Lynch (BOAML) came out with a report predicting that the sort of big gains the U.S. has been experiencing are likely to be slowing because of new-found discipline among the exploration and production (E&P) companies. That has been the assumption in the industry for awhile; the analysts at BOAML went out and spoke to a lot of oil companies in recent weeks to confirm it.
Equity prices in the oil sector have taken a beating. The S&P Energy Select Sector Index as of August 29 had posted a one-year decline of 23.73 percent against a broader S&P 500 that has been largely flat. Those are the types of numbers that get the attention of management. Mighty ExxonMobil (NYSE: XOM) during that time was down about 12 percent. But a pure play producer like Continental Resources (NYSE: CLR), with extensive shale holdings, was down about 35.5 percent.
What the Merrill Lynch management found was that their stock price and their financial performance is becoming more important than just increasing output. Or as the analysts’ team wrote in its report, “Less E&P, more S&P.”
“The challenge for E&Ps is to reposition respective investment cases to compete (side-by-side) with industrials,” the report said. “But managements are conflicted by the appropriate level of growth vs. cash return without risking a de-rating vs. what’s embedded in current valuations.”
In other words, E&P companies are faced with the same sort of dilemma that many trucking companies are faced with. The push to grow market share and serve more routes has been followed by a more sober period in which companies are boasting about achieving a new normal with fewer miles but more profitable ones. Heartland Express (NYSE: HTLD), with its operating ratio less than 80 percent, is a prime example of this. Other companies have said they are striving to get there.
“The single biggest takeaway across all discussions is that capital discipline from U.S. E&Ps and the pivot to balancing growth with free cashflow is real and has the potential to redefine the investment case for energy on multiple levels,” the report said in bold type.
The end result of this discipline, according to BOAML, is that “the days of 2 million b/d growth in lower 48 oil output have passed.”
That actually isn’t a radical forecast. For example, the EIA’s current forecast is that lower 48 output will average a growth rate of 50,000 b/d from the fourth quarter of this year through the end of next year. That would follow on growth of 110,000 b/d per month from August 2018 to July 2019, or about 1.3 million b/d.
Still, that growth rate through 2020 is strong enough that combined with other projected increases from non-OPEC countries in 2020, OPEC is facing enormous pressure in 2020 to make further cuts in production.
A scene from 1974: teenage boy who just got his license and was greeted with gasoline lines during the first big gas crisis, speaking to his father: “When is this going to end?” Father: “Probably when we start getting oil from Alaska.” Son: “When is that going to be?” Father: “About three years from now.” Which to the son sounded like 1,000 years off and so he decided to better understand this whole thing by eventually starting to write about oil.
Yes, that was this writer (though that talk was not actually why I started writing about black gold). I was reminded of that story this week when the news broke that BP (NYSE: BP), which led the push into Alaska in the 1970s, drilled the first well at Prudhoe Bay and which at one time was a leader in the state producing more than 2 million b/d of crude – it’s now about 475,000 b/d – decided to sell its Alaska holdings to privately held Hilcorp Energy for $5.6 billion. Hilcorp already is active in Alaska. BP said in announcing the sale that it has plenty of other opportunities around the world.
But this clearly was the end of an era. Battles over access to new areas are a regular feature of Alaskan activity, with federal policy coming down against new drilling during the Obama administration to be followed by possible policy changes from the Trump administration makes planning difficult. A private company may be able to better handle those ups and downs rather than a public company answering to shareholders in public markets every day.
Still, the assets weren’t exactly given away, fetching more than $5 billion.It’s often something of a maverick company that can make a go of it in an area where others have given up on. All eyes are now on Hilcorp.