Credit, slower output, spending to hit E&Ps in 2016

Analysts Vincent G Piazza, Spencer Cutter, and Michael KayBloomberg Intelligence

E&P activity to shift again as credit may cast pall in 2016

Accommodative policies spurred by global central bank monetary intervention have artificially inflated commodity prices, which had previously delinked from sluggish economic fundamentals. Imbalances have widened, manifested by weaker demand against resilient supply.

Prospects of higher borrowing rates and appreciating U.S. currency continue to pressure dollar-linked energy commodities and will influence lending arrangements in 2016 for high-yield E&Ps whose output growth was underpinned by cheap and easy credit.

Weaker global growth, looser oil balances to hurt prices, E&Ps

Oil supply-demand balances probably loosened in 2015 as the transitory demand boost from restocking collided with persistently higher output from OPEC and the U.S. Expectations for a slight acceleration in global demand in 2016 may be inflated given existing economic sluggishness.

Yet U.S. volume growth, a main driver of global marginal supply, will be more measured should tighter credit underwriting standards suppress E&P liquidity, depressing drilling and hurting cash flow and earnings.

Oil consensus may be too high,available credit might be pinched

Consensus oil price estimates for the reminder of 2015 and 2016 may be elevated, given wide supply-demand imbalances, which may result in further revisions to benchmarks. Lower crude oil prices will challenge E&P volume targets and weaker price realizations will hurt profitability and cash flow.

Yet lower cost structures may partially arrest deteriorating E&P netbacks. Weak fundamentals may constrain E&P liquidity as underwriters move to reassess credit availability by cutting price decks and reevaluate reserves.

Production and capex to fall further hitting more levered E&Ps

Output for the BI E&P peer group may rise 6% in 2015, with growth in 2016 likely below the 4% estimated by consensus. This contrasts with expectations of cash flow declining 34% this year due to depressed benchmark oil prices. Continued pressure on oil prices in 2016 will further depress cash flow.

Cheap credit funded the industry’s revival to its 9.6 million peak in July from 5 million barrels a day in 2008. Capex and volume will be cut further in 2016 as credit standards tighten, limiting financial flexibility.

20085 million barrels a day

2015

9.6 million barrels a day

Dash for cash flow neutrality on weak prices hits E&Ps in wallet

Lower domestic oil and subdued gas commodity prices in 2016 will likely force E&Ps to further cut capital spending from an estimated $89 billion next year.

While BI E&P peers have used about 30% of their credit availability, access may be reduced when borrowing bases are redetermined for some producers in 4Q. Production growth forecasts of about 4% for the group and expectations of improving cash flow in 2016 are likely elevated. Operators will seek cash flow neutrality amid lower prices and credit constraints.

PUDs make up 39% of oil & gas reserves, revisions ahead in 2015

Proved undeveloped reserves (PUDs) not developed within the five-year window permitted by the SEC are subject to revisions, lowering their value and likely decreasing the collateral available for lending arrangements.

PUDs comprised about 39% (22.1 billion barrels) of oil and gas reserves in the BI E&P peer group in 2014, yet are not ascribed similar value as other reserves, given they are undeveloped.

39%

E&Ps could see lower credit availability with cuts to reserves likely at year-end given lower average oil prices.

More permanent E&P capital may be needed after redetermination

Cuts to short-term E&P borrowing bases would require more permanent capital infusions in the form of higher-cost equity or debt. Almost $13 billion of equity and $16 billion of high-yield E&P capital was raised in 2015 to fund purchases and repay borrowing-base credit lines. Yet surging yields and plunging equity prices have raised the cost of capital and may limit funding options. Asset sales are another channel to raise funding, though interest is subdued due to the price disconnect between buyers and sellers.

$13 billionof equity

$16 billionhigh-yield E&P capital

Tighter credit standards in 2016 might not hinder all E&Ps

Credit will likely tighten and borrowing bases will be further constrained for the more-levered E&Ps, limiting their funding options and curtailing their pace of drilling in 2016.

Output from E&Ps with the highest use of their borrowing bases represented just 4% of U.S. output, so industry volume may still be more resilient than expected. Spending will be more closely balanced with cash flow generated for the majority of U.S.-based E&Ps with scale, lower cost and prime acreage, yet output will likely grow.

4%E&Ps

U.S. output

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