ANALYSIS: US E&Ps to keep cost-cutting, cautious approach in 2021 amid COVID-19 concerns

After a year almost wholly engulfed by challenges related to the coronavirus pandemic, US upstream operators in third-quarter earnings calls showcased their lower costs and oil breakevens, added efficiencies and delevered balance sheets as they prepare for 2021.

Many producers proved they could respond quickly to the pandemic's shredding of global oil demand, which in turn tamped down crude prices and forced the sector into months of fiscal austerity. But as they ready for a new year, E&P operators still face issues over the timing of demand return, its effect on crude prices and what their production response will be.

"The primary theme from Q3 calls is production/capex Groundhog Day in 2021," S&P Global Platts Analytics analyst Sami Yahya said, expecting a repeat performance. "Many operators plan to maintain their 2020 exit rates into next year, at best delivering a mid- to low-single-digit growth year on year," Yahya said.

The pandemic "accelerated and deepened" a process was well underway before 2020, Evercore ISI upstream analyst Stephen Richardson said in a Nov. 11 investor note, which included the "end of US oil supply growth and ... a new industry structure built on stable financial footing, achieving sustainability targets, with clear financial incentives for shareholders has emerged."

Drilling, completions improvements

On the bright side, operators touted many achievements in Q3 from the austerity program. Lease operating expenses, the spending associated with an active well and its associated equipment, have dropped and those gains are "likely sustainable" if the forward strip holds into 2021, Tudor Pickering Holt said in a Nov. 10 investor note.

"On the drilling and completions side, capex again trended below expectations as companies continue to improve on days to drill" a well," TPH said. The investment bank added it was "good to hear companies holding the line on [2021 capital allocation] discipline, with the vast majority of both oil and gas producers looking at maintenance capital as the upper end of growth plans."

Some sector fiscal metrics also emerged in Q3 that have quickly become standard, such as a 70%-80% reinvestment rate of cash flows, which allows 20%-30% for other purposes chiefly aimed at returning more cash to shareholders through share repurchases or dividends.

Many E&Ps also plan to limit production growth to mid-single digits, particularly for oil, not only to keep from producing too much of their quality assets into a low-priced market, but also to help keep oil markets balanced and ensure excess supplies don't keep crude prices tamped down.

Upstream producers with the capacity to grow US crude volumes, a number which Evercore's Richardson noted is much smaller than before in a capital-stretched environment, have stated strongly that growth into an oversupplied market in 2021 makes little sense, he said.

"Those with flexibility have reset the cost structure, and breakevens took another leg down into the $30s/b and also reduced the growth bar," Richardson added.

'Shale 3.0' gains momentum

Wells Fargo analyst Nitin Kumar has noticed a shift in management commentary this year toward "voluntary curtailment of growth spending in favor of cash generation and returns," or what he calls "Shale 3.0," which gained momentum during Q3 earnings.

"We expect management teams to stick to this message," Kumar said in a Nov. 10 investor note.

The upstream sector appears to be bringing back rigs in Q4. Occidental Petroleum said this week it will ramp up activity somewhat and bring back four rigs in the Permian Basin of West Texas and New Mexico and in the DJ Basin in Colorado.

The US total oil and gas rig count has moved up 3% to 359 in the first week of November compared to the final week of October.

Wells Fargo analyst Christopher Voie said his investment bank views the 2021 outlook as "highly variable," but estimates Lower 48 E&Ps are set for 10%-15% lower spend in 2021. That would drive only around 5% quarter-on-quarter spending growth in Q1 and Q2 2021 with flat Q3-Q4 2021 spending, Voie said in a Nov. 10 investor note.

"These factors shake out to increased more optimism about the future, even though it appears relatively constricted in the near term," he added.

While operators are now stating a $30/b breakeven price more freely, they would need higher prices of $45/b-$50/b to activate significant growth, something not expected to be realized until 2022 and beyond, Yahya said, noting Platts Analytics' WTI crude price forecast does not break above $45/b until very late in 2021.