Eve of Destruction - Cost Structure Threatens the Survival of Many U.S. Crude Oil Producers

E&Ps have long been accustomed to negative investor sentiment and the depressed stock valuations that come with it. But who among them could have anticipated the first quarter’s devastating one-two punch of coronavirus-related energy demand destruction and the collapse of the OPEC+ supply-management effort that for more than three years had propped up crude oil prices? E&Ps responded by slashing their 2020 capital spending plans and touting how much of their 2020 production is hedged. But there’s no doubt about it, the E&P sector is in for particularly hard times, as evidenced by Whiting Petroleum’s Chapter 11 filing last week. A major impediment for Whiting and other already hobbled E&Ps is a cost structure that, for many, significantly exceeds the current price of oil. Today, we discuss what an examination of more than 30 E&Ps’ lifting, DD&A and other costs reveals about the companies’ ability to stay afloat in rough seas.

In order to identify the companies with the weakest and strongest outlooks in this low commodity price environment, we analyzed the cost structures of the 34 companies in our Oil-Weighted and Diversified E&P peer groups. The data points we analyzed are: lifting costs (including production taxes); depreciation, depletion and amortization (DD&A) expenses; cash interest expense paid (including capitalized interest); and general and administration (G&A) outlays, all using 2019 data found in the company’s 10-Ks. In other words, we’ve tracked the costs of producing oil and gas, paying interest on debt, and paying staff and office overhead. We have excluded impairment charges from this analysis, since they are not regularly occurring expenses; exploration outlays, which tend to be deferred in low-price environments; and income taxes. We computed two metrics: total costs per barrel of oil equivalent (boe) and cash costs per boe. Total costs per boe is the sum of all the data points we highlighted above and can be considered a breakeven point for E&P operations. Cash costs are defined as total costs excluding DD&A expenses, and, in theory, represent the point at which production would be shut-in — i.e., when a producer would see negative cash flow per boe produced.

This analysis also excludes capital expenditures, which we recently analyzed in our blog, “Paint It Black.” In recent weeks, the Oil-Weighted and Diversified companies that we track have announced additional reductions in 2020 capex of more than 40%, which suggest at least a 6% overall decline in their production from initial 2020 estimates. We expect even more reductions in spending and production guidance to be announced in upcoming first-quarter earnings releases. E&Ps are also slashing or eliminating dividends and suspending share repurchase programs to preserve liquidity. Note that we are not considering balance sheets in our analysis, so this is not an assessment of which companies are the ones most likely to succumb to market conditions.