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US upstream companies continue on conservative path in Q3


Cost discipline, drilling activity main items

Capital budgets for 2020 seen possibly lower

Some big operators still see efficiency gains

Houston — E&P companies are expected to outline a conservative approach to future capital spending and activity levels when they release third-quarter earnings in the coming weeks.

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Companies have already said, at conferences and via press releases, that they are focusing on controlling costs and returning cash to shareholders.

"As Q3 reports approach and with a smattering of first looks at 2020 expected from some, the onus is clearly on the sector to 'follow through' on early 2019 promises," Evercore ISI analyst Stephen Richardson said in a Monday investor note.

Those promises chiefly revolve around capital discipline, growing free cash flow and giving more money to shareholders.


Crude oil prices have fallen into the low $50s/b after nesting roughly in the mid-to-high $50s/b much of the year and even climbing into the mid-$60s/b in the second quarter.

But prices are expected to be lower in 2020 than this year. On Tuesday, the US Energy Information Administration said it expected WTI to average $56.26/b for 2019 but $54.43/b next year.

That can't help but have a large impact in 2020 budgets and drilling activity, analysts said.

"[Oil] prices are likely to be a really big theme" of Q3 calls, Paul Horsnell, director of commodities for Standard Chartered Bank, said. "I think [E&Ps] need another $10/b to be back on an even keel."

"It's hard to imagine current capex can be sustained in a $50/b world, so there's likely to be some guiding downwards," Horsnell said. "And where capex goes, so does the rig count."

Consequently, drilling capex for 2020 will be another big focus of the [Q3] calls, Rob Thummel, managing director for upstream at Tortoise Capital, said.

Thummel and other analysts have noted that the US oil and gas rig count has been declining since the end of last year -- dipping to 931 last week after a high of 1,233 in mid-November 2018.

Even as oil prices remain at relatively low levels, the stock market demands that oil and gas producers prove their businesses operate well through free cash flow generation, he said. "Companies that demonstrate the quickest path to free cash flow will be rewarded," said Thummel.


If crude oil prices remain at current levels, E&P capital budgets and production growth may trend lower in 2020, they added.

"It's tough to generate meaningful free cash flow when oil at $50 and gas is at $2.25/Mcf unless you cut spending," said Thummel.

Production growth, once a proud metric for E&P companies, is not as important to the upstream sector as it was in the years before the 2015-2016, analysts said.

Horsnell believes US shale oil output will move into "sequential decline" early in 2020 if the WTI futures curve does not move higher.

"With US oil drilling lower year-to-date by 19.8%, in our view completions in key regions will soon fall below the level necessary to cancel out month-on-month declines ... from existing shale wells," he said.

In addition, majors operating in the Permian Basin may be asked questions about acquisitions as producers there battle to expand in that prolific West Texas/New Mexico field, he added. "If the equity market keeps kicking valuations down, it's hard to imagine that M&A would not accelerate," he said.


Late last month, Goldman Sachs analyst Brian Singer and a team visited CEOs of six Houston-based large-cap independent oil operators, and said the executives appear to be basing 2020 capex on $50/b to $55/b prices -- about the same as in recent years.

Singer's team also found the executives see costs "continuing to fall and remain optimistic on efficiency gains" -- a view that counters some other analysts who claim those gains are slowing. Operators are also "looking to spend less, grow less, and deliver more free cash flow while the rig count continues to fall," he wrote.

The team said some companies have already indicated lower production growth for 2020 compared to this year.

"However, we note most companies in recent meetings/conversations -- EOG [Resources] and Marathon Oil most notably -- still see growth as a key driver of superior corporate level returns, assuming they can continue to drive down costs (managements were broadly optimistic regarding further efficiency gains and lower services costs)," GS added.

-- Starr Spencer,

-- Edited by Kshitiz Goliya,

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