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E&Ps Diamondback, Parsley slash 2020 activity as oil price collapses

Highlights

Diamondback drops three rigs, three completion crews

Parsley likely to cut three rigs 'as soon as practicable'

Returns on incremental wells 'do not hold up': TPH

Houston — The first two of what could eventually be a horde of oil operators said on Monday they plan to slash activity after oil prices plunged, with cuts to capital budgets and output growth also possible.

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Diamondback Energy said it would reduce activity "immediately" to six completion crews from nine, drop two drilling rigs in April and a third later in the second quarter.

Also, Parsley Energy said it is revising its baseline capital budget assumption from $50/b WTI to $30/b-$35/b for the rest of 2020, and will drop three drilling rigs "as soon as practicable."

On Monday, WTI NYMEX oil futures settled at $31.13/b, down $10.15 from Friday's closing price. Last week, OPEC attempted to shave more global production from an existing 1.7 million b/d of cuts, but Russia declined to participate, leaving oil markets open to a likely supply glut.

"As a result of current and expected oil price weakness, we have immediately reduced development activity and expect lower activity levels to continue until we see clear signs of commodity price recovery," Diamondback CEO Travis Stice said in a statement.

"While this decision is expected to result in lower 2020 oil production than originally forecast, we will maintain positive cash flow and protect our balance sheet and dividend," Stice said.

The company has already dropped one completion crew as part of its original 2020 plan, but is now releasing two more completion crews as a result of the "recent and expected" oil price weakness, its statement said.

CAPEX TO BE REDUCED, BUT NO FIGURE GIVEN

Diamondback also said it plans to reduce its capital budget for the year, although it did not name a lower capex figure or percentage reduction. The company said it was "well-protected" with hedges this year for a majority of its production.

Last month, the company reaffirmed a projected $2.450 billion to $2.6 billion of capital spending for 2020 that it had signaled late last year.

But going forward, Diamondback's "drilling, completion and equip" spend for 2020 should decrease through lower completed well count, lower expected well costs, while corresponding infrastructure and midstream capex should also fall, it said.

The company averaged 195,000 b/d of oil production in Q4 and 301,300 boe/d total output. For full-year 2020 it had expected 310,000 boe/d-325,000 boe/d of total production and 205,000-215,000 b/d of oil output.

In addition, Parsley Energy operated 15 development rigs during January and February and an average of five hydraulic fracturing crews. On March 6, it dropped to three frac crews, and now plans to drop to 12 rigs.

Moreover, the company said it plans to further reduce its activity pace in the near term.

"Consistent with the company's commitment to free cash flow generation and in response to recent commodity price trends, Parsley has begun to reduce development activity in 2020," the company said in a statement.

LESS CASH FLOWS WITH LOWER OIL PRICE

The company previously said it had expected to generate at least $200 million of free cash flow during 2020 at $50/b WTI. Assuming $30/b-$35/b WTI oil prices for the rest of the year, it would target at least $85 million of free cash flow, achieved through incremental activity reductions, likely also together with lower service and equipment costs.

"A strong balance sheet and corporate agility [are] critical in these challenging and volatile times," Parsley CEO Matt Gallagher said. "We must act swiftly to preserve a stable free cash flow profile and [do] whatever is necessary to protect our balance sheet in the weeks and months ahead."

"This approach worked in the 2015-2016 timeframe and will best position us again to emerge from this volatile time on our front foot ready to fight," Gallagher said.

The company will provide more detail on its formal 2020 guidance with its first-quarter 2020 financial results "or as needed."

The fact that 40% to 50% of a well's ultimate estimated oil recovery is produced in the first two years, coupled with high upfront well costs at $7 million-$10 million apiece, leaves industry "very sensitive" to changes in the front-end forward curve, investment bank Tudor Pickering Holt said.

"We estimate the average upstream producer [that TPH covers] has a cash operating cost including G&A, interest, royalties, etc. of $17/b to $22/b, drastically compressing cash flow at this price," the bank said in an early Monday note.

"Additionally, returns on incremental wells do not hold up as our coverage, generally, needs $45/b-$55/b to generate a 30% after-tax rate of return," the bank said. "With crude below $35/b WTI, we believe the industry should quickly shift to drop completions crews as most are on well-to-well or month-to-month contracts and wait until commodity prices rise before trying to stabilize production," TPH said.

KeyBanc analyst Leo Mariani said he does not expect the oil price rout to trigger many near-term issues for the majority of public E&P's.

"[But] I think borrowing base redeterminations this spring tighten liquidity a lot for many companies," Mariani said. "Bankruptcies may be triggered for those companies who have bonds coming due but are unable to refinance/repay them."

"I think mergers will be frozen right now until oil prices settle out," he added, as companies will be focused on liquidity and activity reductions near-term rather than consolidation.

"Ultimately, I still think the Permian names are most likely to merge when the dust settles," Mariani said.

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