Reinvent the Wheel - Many Diversified E&Ps in Major Realignments, Shifting Toward an Oil Focus

After cutting capital investment 71% between 2014 and 2016, the 13 diversified U.S. exploration and production (E&P) companies examined in our Piranha! market study are planning to increase 2017 capital spending by 30%. While this seems like a lackluster rebound compared to the 47% boost announced by oil-focused E&Ps, the diversified group’s totals are skewed by the pull-back strategy of giant ConocoPhillips. Excluding ConocoPhillips, the 12 other companies are guiding to a 48% increase in 2017 investment—very similar to their oil-weighted peers. Today we continue our Piranha! series on upstream spending in the crude oil and natural gas sector, this time zeroing in on E&Ps with a rough balance of oil and gas assets.

U.S. oil and natural gas E&P companies, anticipating continuing low crude oil and natural gas prices, have been reshaping their portfolios to focus on a half-dozen top-notch resource plays whose production economics can hold up even if prices were to soften further. The biggest of these asset purchases and sales grab the headlines, but countless other, smaller-bite deals are having profound effects too. Taken together, this piranha-like devouring of E&P assets in the Permian, the SCOOP/STACK and other key production areas is transforming who owns what in the plays that matter most, and positioning a select group of E&Ps for success.

Piranha! The “Piranhaization” Of U.S. E&P

Concentration Of Assets, Targeted Acquisitions, And Strategic Divestitures Separate The Winners From The Losers In A $50/Bbl Crude Oil World

Piranha! is a market study about understanding this industry-wide transformation, identifying the companies best positioned for success, and predicting how the changes in U.S. E&P sector will continue to dominate the supply side of the supply/demand balance, not only in the U.S. but around the globe.

Click Here for More Information on our Piranha! Report

We examine this ongoing transformation in Piranha!, our new market study of 43 representative U.S. E&Ps. Of that universe of companies, 21 focus on oil (60%+ liquids reserves), nine are gas-weighted producers (60%+ natural gas reserves) and 13 are diversified producers. All of the major U.S. shale/unconventional plays are represented in the combined portfolios of these firms. In Very Particular Places to Go, we discussed the purpose and organization of our analysis. The first part of the four-part market study examines the strategies that companies are adopting to thrive in a $50/bbl world, breaking down merger and acquisition (M&A) activity by basin to show where these firms are selling and where they are buying. The second part considers the E&P sector’s 2017 capital spending plans and production expectations as a whole, while the third delves into what these companies have been doing to maintain and improve their financial health. The fourth and final section of Piranha!, which accounts for more than 120 of the report’s 150-plus pages, examines each company in our universe of 43 firms at a granular level, looking at their financial condition, capex plans, geographic focus, M&A strategies and a general assessment of the company’s position in today’s U.S. E&P industry.

Then, in All the Right Moves, we highlighted one of the 43 E&Ps—Anadarko Petroleum—as a prime example of the piranha-ization of the U.S. oil and gas industry. Since the beginning of 2014, Anadarko has sold more than $12 billion in assets, including properties that generated one-third of its 2016 production, to focus 80% of its capital investment on just three U.S. plays. In Jump!, we took an initial look at the 2017 capital spending plans of the three peer groups of E&Ps—Oil-Weighted, Gas-Weighted and Diversified. Most recently, in Higher Ground, we took a deep dive into the Oil-Weighted peer group, which is expecting a 47% increase in 2017 capital spending and a 7% gain in production.

Today, we focus on the Diversified E&P peer group.  As illustrated in Figure 1, total capital spending by the 13 diversified E&Ps is increasing only 30% to $19.7 billion (red circle in Figure 1), which is 63% below the peer group’s 2014 investment. However, excluding the 4% decline in investment by ConocoPhillips (orange circle), which accounts for 25% of total peer group investment, capital outlays by the group are 48% higher than in 2016—an increase on par with the Oil-Weighted peer group.

Figure 1: Diversified E&P Peer Group Capital Spending and Production Data. Source: RBN (Click to Enlarge)

The group’s 2017 production (measured in barrels of oil equivalent, or boe) is expected to be 5% lower than last year, at 1.574 billion boe (yellow circle in Figure 1), slightly more than the decline seen in the 2014-16 period.  Property divestitures have heavily influenced the 2017 output level.  Seven of the 13 companies in the Diversified peer group are anticipating production declines, and four of those seven are expecting double-digit output declines in 2017.

The allocation of the Diversified E&Ps’ spending increases is significantly more, um, diversified than that of the oil producers. Figure 2 shows how the Diversified peer group’s planned 2017 investments (pie chart to right) by play compares to the group’s 2016 investments (pie chart to left). The Permian (dark blue pie slices) in 2017 continues to receive the largest allocation of Diversified E&Ps’ capital, at 28% of total capital budget, but that’s down from 36% in 2016 and much lower than the 46% allocation by the Oil-Weighted peers.

Figure 2: Diversified E&Ps’ 2016 and 2017 Capital Spending by Play. Source: RBN (Click to Enlarge)

The Denver-Julesburg (DJ) Basin (dark orange pie slices) is scheduled to receive 11% of the diversified group’s budget, more than double the 5% allocated to the DJ Basin in 2016. But the SCOOP/STACK capital allocation (aqua pie slices) has been slashed in half, from 20% of capex in 2016 to only 10% in 2017.

When considering the Diversified E&Ps on a company-by-company basis, ConocoPhillips stands apart from its peers, and not just because it is by far the largest in the group. ConocoPhillips also is an outlier because it had until recently been a major international, vertically integrated oil giant; it has since spun off its midstream and downstream assets to focus on the E&P side of things. Unlike the other diversified E&Ps, production growth has been on the bottom rung of the company’s priorities. That’s why it has been sharply reducing capital outlays—from $20.1 billion in 2014 to $11.8 billion in 2015, $5.2 billion in 2016 and $5.0 billion in 2017. ConocoPhillips also has been pursuing asset sales; in the last month, the company has been able to meet its three-year financial targets through $16 billion in proceeds from the sale of part of its Canadian oil sands portfolio, its Canadian Deep Basin gas assets, and its San Juan Basin gas assets. The downside of the sales is that the company has shed 25% of 2016 production. ConocoPhillips plans to spend the largest amount of its reduced capital budget in the Lower 48 states, with the Eagle Ford Shale getting the largest allocation (about 14% of total capex), followed by the Bakken (11%) and the Permian (6%). Prior to the announcement of these asset sales, the company had been expecting a 1% increase in production in 2017.

Two of the top three companies in capital spending gains in 2017 are recovering from draconian capex cuts between 2014 and 2016.  Bill Barrett Corp. is nearly tripling capital spending in 2017 to $270 million. The company slashed capital outlays more than 80% in 2014-16, from $551 million in 2014 to $95 million in 2016. But the convergence of higher oil and gas prices and lower drilling costs has made its DJ Basin core assets economically viable again.  W&T Offshore is increasing capex seven-fold to $125 million after capital outlays were slashed to only $15 million in 2016 from $610 million in 2014. The company has faced hard times, but has been working to fix things. The short reserve life of its Gulf of Mexico assets—illustrated by its 2016 reserve/production ratio of five years compared to the peer group average of 11 years—make it critically important for W&T Offshore to resume investment. The company is expecting to increase production by 4% in 2017.

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The company that posted the third-largest 2017 spending gain, WPX Energy, is expecting to increase capital spending by 113% to $905 million. WPX has completely transformed itself through piranha-like M&A activity, shifting from a majority gas producer to a diversified company allocating 55% of its capital to the oil-focused Permian and an additional 27% to the oil-focused Bakken. WPX invested more than $3 billion in the Permian to establish its position there while selling off gas assets, including its Piceance Basin acreage in 2016.  WPX is anticipating a 28% production gain in 2017.

The two weakest spending increases in the Diversified peer group were posted by SM Energy and Newfield Exploration. SM Energy is only increasing capital investment by 5% in 2017, to $750 million. The company has been aggressively realigning its portfolio, divesting more than $2 billion in Bakken assets in 2016-17, and reinvesting that cash flow in the Permian. SM Energy is spending 86% of its 2017 capital budget in the Permian, with the balance being invested in the Eagle Ford. The company is expecting a substantial decline in production because of its assets sales, but moving forward it expects 15% growth in oil and gas production by 2019.

Newfield Exploration is planning to spend $850 million in 2017, 14% more than in 2016. The bulk of the company’s 2017 capex is being directed toward the SCOOP/STACK, with minor capital being allocated to the Uinta Basin and the Bakken. Newfield is expected to shrink production by 14% in 2017, but if adjusted for asset sales, production would be up 4%. The company believes it will increase production 10%-15% annually through 2019.

Other companies of interest include EnCana Corp. and Devon Energy. EnCana has reorganized its portfolio through $14 billion in M&A activity since 2014, all with the aim of reinventing itself as an oil/liquids producer—a shift from the natural gas behemoth that it once was. In 2017, EnCana says it will spend $1.4 billion in its upstream operations, with nearly 60% focused on the Permian. The company expects to see a total production decline of 7% from 2016, but core asset production growth is expected to be greater than 20% between the fourth quarter of 2016 and the fourth quarter of 2017.

Devon Energy has also been reformulating its portfolio over a number of years, first selling off offshore and non-North American assets and more recently readjusting its domestic portfolio. In 2017, Devon is expected to increase capital spending 84% to $2.2 billion, with most of the outlays being allocated to U.S. resource plays—two-thirds targeting the Permian and the SCOOP/STACK and the balance scattered in the DJ Basin, the Eagle Ford and in Canada. Production is expected to fall 10% in 2017, but U.S. oil production is expected to increase by 15% this year and 20% in 2018.

Generally speaking, many of the Diversified E&Ps examined in the Piranha! market study have been undergoing major realignments to better position themselves for a sustained period of lower oil and gas prices. A few are placing big bets on the Permian, but others are looking elsewhere, including SCOOP/STACK and the DJ Basin. Time will tell which of these strategies prove to be the most effective.

For more on Piranha!, click here to download a preview of the market study.

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“Reinvent the Wheel” was a song from the country, rock and bluegrass band Alabama’s 2001 album, When It All Goes South. This was the group’s 19th album, its final effort for RCA, and Alabama’s last release before it announced its American Farewell Tour in 2002.