In their second quarter 2016 earnings announcements, North American exploration and production companies (E&Ps) announced relatively minor changes to the steep reductions in 2016 capital budgets they unveiled around the first of the year. Total 2016 “finding and development” spending for 46 leading U.S. producers was an estimated $41.0 billion, down 51% and 70% from investment in 2015 and 2014, respectively, and slightly lower than the $41.9 billion forecast for 2016 spending in year-end 2015 announcements. The second-quarter reports over the past few weeks also confirmed the initial guidance of a 4% production decline in 2016 after 7% and 6% increases in 2014 and 2015. However, as we discuss today, a look behind the headline numbers indicates that cuts in capital expenditures (capex) look to have bottomed out, and that the industry may be poised for a turnaround in drilling activity later this year into 2017.
One important sign of this apparent turnaround is a more than 20% increase in the U.S. drilling-rig count since the last week in May. That gain reverses two years of steady weekly declines, although the current count of 496 rigs represents only one-quarter of the number operating at the peak in mid-2014. While the Permian Basin accounts for the majority of the new rigs, signs of renewal are popping up in other basins like crocuses emerging from snow-dusted lawns in early spring.
Before we take a closer look at the current trends, let’s review how we got here. RBN Energy has been closely following industry investment since the beginning of 2015. In Episode 1 of this series back in May 2015, we provided an overview of the 2015 capital spending and oil and gas production trends for our “universe” –– a select group of the 30 largest U.S.-based E&P companies –– based on guidance given during the first quarter of 2015. Our goal was to understand how companies are responding to the challenge of lower oil prices in their capital spending (i.e. drilling) and expectations for production (productivity). We divided the universe into four peer groups: Small/Mid-Size Oil-Weighted E&Ps, Large Oil-Weighted E&Ps, Diversified Natural Gas-Weighted E&Ps, and the Appalachian Gas-Weighted E&Ps. In Episode 2, we did a deeper dive analysis into the two oil-weighted peer groups in the study. We found that the Large Oil-Weighted E&Ps were cutting back by a lower percentage than the Small/Mid-Sized Oil-Weighted E&Ps because the bigger players are generally more financially secure and are better able to fund investment through the price cycle. The Small/Mid-Sized Oil-Weighted E&Ps, meanwhile, were focused on aligning spending with cash flows, with the aim of self-funding capital investment. In Episode 3, we analyzed the natural gas-weighted peers. Our analysis revealed that the U.S. diversified natural gas companies were slashing capital spending in light of weak profitability, which in turn dampened production growth. In contrast, the Appalachian gas producers were the most profitable group in our analysis because they were slashing costs while still increasing their output. In August 2015 (Episode 4), we updated our analysis to reflect second quarter 2015 guidance and noted that the Small/Mid-Sized Oil-Weighted E&Ps were the only peer group growing capital spending given the weak oil and gas price environment. In Episode 5, we updated our analysis of all peer groups based on year-end 2015 earnings releases and 2016 guidance issued by our 30 target companies. In our most recent update (Episode 6), we highlighted that oil and gas production finally started to level off after nearly two years of crushing capital spending declines.