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With a U.S. Government Shutdown, There Will Be Blood

Several majors could make a play for Permian producer Endeavor Energy

IEA warns of oil supply lagging demand without significant investment

Permian producers prepared for dip in oil prices to last into 2019

Stocks Rocked the House Post Midterm Elections

With a U.S. Government Shutdown, There Will Be Blood

When Congress returns from recess after the Labor Day holiday, they have a lot of high-stakes deadlines to resolve. First on their list: to extend funding for government agencies and raise the nation's debt ceiling. Otherwise, the government shuts down, and once again Congress will leave Washington, and with it, the Republican strategy to rewrite the federal tax code in an effort to rescue their struggling legislative plans will be sidelined.

S&P Global Ratings U.S. economics team continues to see the likelihood of a shutdown in late September as slim, with the crisis from Hurricane Harvey further reducing the chances. But betting on a rational U.S. government can be risky. With that in mind, assuming that the government crosses that line, S&P Global economists estimate that a shutdown could shave approximately 0.2 percentage points, or $6.5 billion, off of real fourth-quarter GDP growth for each week it drags on. If a shutdown were to begin later in the fourth-quarter, the hit to quarterly GDP growth would be even larger. But, since this shutdown would potentially happen at the start, some initial losses would be regained once government facilities are back in operation. Other economic activity, however, including lost productivity from furloughed government employees, would not be recovered.

  • S&P Global economists predict a government shutdown, if it began early in the quarter, would shave about 0.2 percentage points, or at least $6.5 billion, off of real fourth-quarter GDP each week it continues.
  • A shutdown affects not only Washington and its employees but has ripple effects across sectors throughout the country--from shopping malls to national parks--from contractors to hotels.
  • Our analysis is based in part on the 1995-1996 government shutdown and the more recent 16-day shutdown during the Obama Administration in October 2013.
  • A shutdown comes at the same time as the Treasury hitting the debt ceiling. Failure to raise the debt limit would likely be more catastrophic to the economy than the 2008 failure of Lehman Brothers and would erase many of the gains of the subsequent recovery.

At first blush, chances of a shutdown seems highly unlikely, given the administration is Republican and the GOP holds majorities in both the House and the Senate (albeit, slim ones). However, the recent comment by President Trump at the Arizona rally on Aug. 22--"If we have to close down our government, we're building that wall," referring to the proposed Mexican border wall--and reiterated by the White House on Aug. 24, has raised the specter that a shutdown is looming at the end of September. At the same time, a debt-ceiling impasse would leave the Treasury with insufficient cash to meet all financial obligations, making a very bad situation much worse.

Although lawmaker Paul Ryan doesn't think that "anyone is interested in a shutdown," the president can veto any spending bill that reaches his desk, ultimately forcing closure of the government. Conversely, Congress may have the incentive, and enough votes, to override a presidential veto in order to avoid a shutdown.

Our analysis is, in part, based on the experience of the back-to-back shutdowns of almost four weeks that happened during the Clinton Administration in 1995-1996 and the more recent 16-day shutdown during the Obama Administration in October 2013. While the Bureau of Economic Analysis (BEA) said that the full effects of the partial October 2013 shutdown can't be quantified, they estimated that the direct effect from lost hours worked by federal employees reduced fourth-quarter GDP by 0.3 percentage points. (The BEA earlier estimated that one-third of the 11.9% decline in federal spending and investment in the fourth-quarter 1995 GDP report was due to the shutdowns of the federal government in mid-November and late December.)

The Butterfly Effect

The BEA estimated only the direct impact of the shutdown. But, since the government touches almost every aspect of the economy, the full effect of a shutdown would likely be much larger. A disruption in government spending means no government paychecks to spend at the mall, lost business and revenue to private contractors, lost sales at retail shops, particularly those that circle now-closed national parks, and less tax revenue for Uncle Sam. That means less economic activity and fewer jobs. We expect something in line with the Council of Economic Advisors (CEA), which earlier estimated that 120,000 fewer private-sector jobs were created during the first two weeks of the 2013 shutdown.

Ironically, a possible shutdown will add to the budget deficit, because it's costly to stop and start programs. Based on the total cost of furloughed federal workers, the 16-day shutdown in 2013 cost the U.S. government at least $2 billion, according to the Office of Management and Budget (OMB), while the two 1995-96 shutdowns cost the U.S. government $1.4 billion ($2.2 billion in today's dollar).

A shutdown will initially slow GDP, because the output lost when hundreds of thousands of government workers are furloughed subtracts directly from GDP. And, with each day the shutdown drags on, federal workers may start to pull back on household spending, at restaurants, childcare, or retail stores because of worries that they won't get paid anytime soon. That's almost 1 million people who won't be getting regular paychecks.

Yet the economic impact of the shutdown goes beyond the federal workforce.

Private contractors who depend on government sales will lose business. During the 2013 shutdown, according to a National Association of Government Contractors survey, 29% of members said that, as a result of the stalemate, they planned to delay hiring. Fifty-eight percent said it would have a negative effect on their business. As contractors delay project, reverberations will be felt throughout the spending chain. This will likely have a ripple effect that spreads through to the economy more broadly.

Vacations and school trips will likely be curtailed when hundreds of national parks and monuments are closed for business. (Even the Panda Cam at the Smithsonian will be under lock and key.) With national parks spread across the U.S., closing these sites does not just mean lost ticket sales. Many regional economies depend almost entirely on visitors to nearby national parks. Those visitors eat at their restaurants, stay at their hotels, and shop at local businesses. That creates jobs, which may no longer be needed if a shutdown drags on.

The End of Days

Businesses don't want to invest during periods of uncertainty, and households will likely delay spending. We saw huge effects during the U.S. debt ceiling crisis in the summer of 2011, with consumer confidence hitting a 31-year low in August, and third-quarter annualized real GDP growing just 0.8%. Given that this round of debt-ceiling negotiations will happen amid government shutdown threats, the hit to the economy could be even more severe.

This all is a prelude to the Treasury Department's hitting the debt ceiling on Sept. 29, 2017, one day before the expiration of the bipartisan spending agreement to fund government agencies. With markets somewhat jittery about a possible selective default of the U.S. sovereign, worries of a shutdown threat only adds to their concerns. The shutdown and the looming debt ceiling combined could significantly hurt business and consumer sentiment, as well as the overall economy. Government disarray leaves GOP lawmakers' hope to approve a compressive tax plan, or even our expectation for a modest tax cut, by early next year, now seem like wishful thinking.

While we believe the Senate will pass its deal to raise the debt ceiling, the impact of a default by the U.S. government on its debts would be worse than the collapse of Lehman Brothers in 2008, devastating markets and the economy.

Should a default occur, the resulting sudden, unplanned contraction of current spending could see government spending cut by about 4% of annualized GDP. The economy would fall back into a recession, wiping out much of the progress made by the recovery.

Finally, the economists at the Federal Reserve, whose monetary policy is now "data-driven," will no longer have government economic reports, such as the Bureau of Labor Statistics' jobs figures, that they need to understand what's going on in the U.S. economy. The length of time that the central bank is without data could add more uncertainty to the Fed's decision that an economic recovery is making progress and cause members to push out the start of the tapering. And with the risk of a government shutdown as we head toward the debt ceiling increasing, the Fed will be more cautious. While we still expect the Fed to announce plans to gradually unwind its balance sheet, their likely plans to delay interest rate hikes until next year will be even more justified. In turn, the economists at S&P Global, like those from across a multitude of sectors, may be forced to re-examine our forecast for the U.S. and the prospects for potential long-term economic growth.

According to the OMB, the last three government shutdowns already cost the federal government over $4.25 billion, when we adjust for inflation. These numbers don't begin to account for lost federal worker productivity and lost trust in the federal government, not to mention lost economic activity (and lost taxes) on money never spent by businesses and households while the government is closed. While we at S&P Global Ratings continue to see the likelihood of a shutdown in late September as slim, the risks are increasing, with the costs high.


Several majors could make a play for Permian producer Endeavor Energy

Oil majors Exxon Mobil Corp., Chevron Corp., Royal Dutch Shell PLC and ConocoPhillips are all considering making first-round bids for Texas-based oil producer Endeavor Energy Resources LP.

Including debt, Endeavor, which holds more than 300,000 acres in the prolific Permian Basin, could be valued at $12 billion to $15 billion. Core acres are located in Martin, Midland, Upton, Glasscock, Reagan and Howard counties. The company's net production in the second quarter was 64,000 barrels of oil equivalent per day, 75% of which was oil.

Many of the majors have highlighted their renewed interest in the U.S. shale plays. Having announced plans earlier this year to triple its Permian oil production to 600,000 barrels per day by 2025, Exxon is viewed by many as the most logical would-be buyer of Endeavor. Back in 2014, Exxon inked a seven-year deal with the producer to expand its presence in the basin.

Exxon's third-quarter shale oil output from the Permian was up 57% on the year due to the ramp-up to the current 38 rigs in the Midland and Delaware basins. The company's third-quarter Permian production increased 170,000 boe/d, or 11%, on the quarter.

While Chevron could be a contender, the company already has a sizeable position in the Permian, analysts said. "Chevron is another possibility although we think its existing position of 1.7 [million] acres (0.5 million Midland and 1.2 million Delaware) is likely adequate, with the focus likely to be more on acreage swaps and trades to core up its position," RBC analyst Biraj Borkhataria wrote in a Nov. 13 note.

Analysts said ConocoPhillips and Shell are less likely to emerge as bidders.

"Despite the company's positive disposition to the play, we would not expect Shell to bid for such a large package given the company has been clear that inorganic activity is included within its $25 [billion] to $30 [billion] capex framework per annum, meaning limited headroom to execute such a large deal," Borkhataria said.

Should a sale occur, it would follow a rash of Permian-based transactions, including Concho Resources Inc.'s purchase of RSP Permian for $8 billion and Diamondback Energy Inc.'s purchase of Energen Corp. for $9.2 billion. Additionally, on Oct. 31, BP PLC closed on its $10.5 billion acquisition of BHP Billiton Group's U.S. shale oil and natural gas assets.

In emailed requests for additional details on a sale, officials from Endeavor, Exxon, Shell and ConocoPhillips declined to comment. An inquiry to Chevron was not immediately returned.

Endeavor, which is family owned, agreed to explore a sale after receiving inquiries from prospective bidders, although the family reportedly would prefer an IPO next year so it could retain control. JP Morgan Chase & Co. and Goldman Sachs Group Inc. were reportedly selected to arrange the possible transaction.

IEA warns of oil supply lagging demand without significant investment

The International Energy Agency warned in its World Energy Outlook 2018, released Nov. 13, that without sufficient oil production investment, the world faces a possible oil supply gap during the early 2020s.

"Oil and natural gas will be part of the energy system for decades to come — even under ambitious efforts to reduce greenhouse gas emissions in line with the Paris Agreement," the report said.

Under existing and planned policies included in the report's new policies scenario, trucking and aviation demand will drive global oil consumption to 102.4 million barrels per day by 2025. Meanwhile, the IEA projects currently producing oil fields will supply just 68.0 MMbbl/d.

"The level of conventional crude oil resources approved for development in recent years … is only half of the level needed to meet demand growth in the [new policies scenario]," the report said.

"If these approvals do not pick up sharply from today's levels, U.S. tight oil production would need to triple from today's level to over 15 [million barrels per day] by 2025 to satisfy demand," the report said. "With a sufficiently large resource base, this could be possible. But it would require levels of capital investment that would far surpass the previous peaks in 2014."

Among trends to 2040, the IEA outlined a "major shift in the geography of oil demand."

According to the report, developing economies will see oil demand grow by 18 MMbbl/d from 2017 to 2040, offsetting a demand decline of 10 MMbbl/d in developing economies.

The IEA projects global oil demand from trucking will grow by 3.9 MMbbl/d, while global oil demand from petrochemicals grows by 4.8 MMbbl/d.

At the same time, the IEA expects oil use in cars will peak in the mid-2020s. It projects approximately 300 million cars on the road by 2040 will avoid 3.3 MMbbl/d of oil demand that year, while efficiency improvements in nonelectric cars will avoid more than 9 MMbbl/d of oil demand in 2040.

The IEA projects automotive demand for oil will decline by 5 MMbbl/d from 2017 to 2040 in advanced economies, offsetting demand growth of 5.4 MMbbl/d in developing economies.

Permian producers prepared for dip in oil prices to last into 2019

Mindful of the lessons learned during the 2014-2016 oil and gas price collapse, large independent producers in the Permian Basin are shielded from the current U.S. oil price slide, thanks to conservative budgeting, new access to Brent crude pricing at the Houston Ship Channel and greater efficiency.

The price of West Texas Intermediate crude oil bounced back above $60 per barrel on the morning of Nov. 12, a slight improvement over the end of the previous week but still well below the $76.40/bbl reached in early October. If prices remain near $60/bbl, that will be more than enough for most producers to see healthy returns, as many have budgeted for prices at $50/bbl or below. Even though prices spiked more than $20/bbl above anticipated levels for several months, Permian producers largely made only slight increases to budgets as they looked to the long term.

"The industry has been conservative in oil price assumptions," Williams Capital Group LP analyst Gabriele Sorbara said. "I would say a majority of 2018/2019 budgets are contemplated on $50-$60/bbl WTI."

EOG Resources Inc., one of the largest producers in the region, assembled a capital budget for 2018 assuming oil prices at $40/bbl and gas prices at $2.50/Mcf, and the company intends to take a similar approach in 2019.

"We're not going to increase capital at the expense of efficiencies and returns. We will develop our assets and spend capital at a pace that will optimize our learning curve and allow sustainable improvement to our well productivity and cost structure," EOG CEO William Thomas said. "Any production growth is strictly the result of disciplined capital allocation to high-return assets. … We are continuously resetting the company to deliver strong returns, even in a low to moderate oil price environment."

When capital budgets for 2018 were assembled, most Permian producers assumed that WTI would hover around the $50/bbl level for much of the year. Even though they recognized far more revenue during the second and third quarters than initially anticipated, they seem content to stay the course at similar levels for 2019.

"What matters for companies is the long-term expectation," said Raymond James & Associates analyst Pavel Molchanov, who anticipates that most companies will continue to build budgets based on prices near $50/bbl. "The futures pricing for 2019 is pretty close to what it was a year ago."

Unlike the situation facing Permian producers during much of the price collapse, many independents have a new advantage, in spite of pipeline constraints: exports to Europe and Asia through the Houston Ship Channel. The exposure to offshore markets and Brent crude prices has allowed them to increase their revenues, as Brent crude was trading at more than $71/bbl on Nov. 12.

Pioneer Natural Resources Co. CEO Timothy Dove said during the third-quarter earnings call that his company would stick to its $3.4 billion budget for 2018 and is likely to take a similar course in 2019. But Dove said Pioneer is now able to avoid the consequences of a WTI price drop due to large amounts of its Permian crude being exported.

"We are now essentially a Brent-priced company if you talk about our oil sales," he said.

Another lesson learned from the price collapse was a continued push for efficiency, with producers using new technologies and methods to cut costs while increasing production. During Anadarko Petroleum Corp.'s third-quarter earnings call, executives said the company's more efficient operations would allow it to recognize "double-digit" production growth while maintaining a budget anticipating $50/bbl prices.

Apache Corp., which is increasing its Permian operations with the development of the Alpine High play, said it would operate in 2019 with a capital budget of $3 billion, lower than in 2018. "If changes in expected cash flow dictate, we have the flexibility to reduce our activity levels accordingly," CEO John Christmann said. The move by Apache and other producers to follow long-term price expectations and not become overly exuberant over higher prices earlier this year may have allowed companies to hold steady heading into 2019.

"Capital spending should be either stable from what it is this year or modestly higher, but no one should expect cuts in capital spending from recent levels because this year's capital programs always lagged behind the uplift we saw in prices we saw in the summer months," Molchanov said.

Stocks Rocked the House Post Midterm Elections

After the S&P 500 logged its 9th worst Oct. on record, losing 6.9%, it has bounced back 2.6% month-to-date through Nov. 9, 2018. Though the monthly returns for the eight Novembers following the historically bad Octobers were only positive twice – in 1978 (President Jimmy Carter midterm year) and 1933 – the fact there was a midterm election this year may help the chance of a solid rally if history repeats itself. Historically, the S&P 500 has been positive in most periods after the midterm elections.

In the months of Nov. and Dec. during historical midterm election years, the S&P 500 gained 14 of 22 times in Nov. and in 15 of 22 times in Dec. with a combined 2-month gain in 17 of the 22 midterm election year-ends. In percentage terms, the S&P 500 gained in 64% of midterm election Nov. months and 68% of the following month that when combined into a 2-month return resulted in gains 77% of the time. Also, the magnitude of the average gains in the 2-month period was 6.1%, more than the magnitude of the average loss of 4.1%.