The upturn begins

In the wake of an historic downturn, Evercore ISI projects that global E&P capex will increase 1.7% during 2017, the first annual increase since 2014. Global upstream spending fell 27% in 2016, after dropping 21% in 2015. This two-year stretch marks the first consecutive set of annual declines since the mid-1980s.

Table 1. North American upstream spending. Source: Evercore ISI, Barclays, company data.

As expected, the most severe reductions in upstream investment last year materialized in North America, where capex was set to fall 41%, following a 33% decline in 2015. Emerging from the bottom, North America will usher in the up-cycle with a 21% increase in E&P capex during 2017, led by a 25% increase in the U.S. Canadian capex is projected to increase by a more

Table 2. Global upstream spending, excluding North America. Source: Evercore ISI, Barclays, company data.

modest 10%, Table 1.

International spending is, however, projected to fall 4.1% this year, following a 21% contraction in 2016, Table 2. The pace of the decline is moderating, however, and the company expects 2017 to mark the bottom for international capex. (Editor’s note: These projections were released in early December and may prove too conservative given subsequent developments.)

OPEC/Non-OPEC pact. A surprisingly decisive OPEC agreement to cut output 1.2 MMbopd, coupled with the 0.6 MMbopd of announced non-OPEC production cuts, will likely precipitate a significant activity increase in North American shale during first-half 2017.

Following the production pact, shale will have the opportunity to prove whether it can fill the role of world’s swing producer. The stage is unequivocally set for substantial activity increases in North America during 2017, while most other energy-producing regions scale back operations. First-half 2017 will thus become a critical juncture for the oilfield services industry, particularly in North America. The impact of labor constraints, and the state of idled equipment, will soon be evident.

Spending likely to exceed results.While Evercore ISI’s survey—which looked at data from almost 300 companies—is accurate during times of stability, periods of price volatility can quickly impact oil companies’ spending plans. Evercore ISI began the data collection process before OPEC’s November agreement, and thus a significant amount of the data reflects the uncertainty surrounding a potential OPEC deal and correspondingly lower commodity prices. The trajectory of commodity price levels through first-half 2017 could have a further impact on ultimate spending levels, particularly in North America, where investment can be rapidly deployed (or reduced). Given that current commodity price levels exceed the average prices that respondents used to budget 2017 capex, we see an up-side to our forecasts in the near and intermediate term.

Cash flow. It comes as no surprise that cash flow and oil prices are the leading determinants of 2017 budget decisions. These two factors have ranked first or second over the past seven years, following the 2000–2010 stretch when natural gas prices were the most often cited determinant in 10 of the 11 years.

Service price inflation.Service pricing fell sharply, and swiftly, at the onset of the downturn and throughout most of 2016. Evercore ISI estimates that overall service pricing has fallen 20% to 70% from 2014 peak levels, depending on service product lines, geographic location, service provider, and a host of other variables. Pricing has generally remained at or below break-even levels throughout 2016, especially in North America, where negative EBITDA margins are par for the course. While it’s not surprising, given the depressed pricing levels and recent commentary from service providers and E&Ps alike, it’s refreshing to see that zero respondents budgeted for further pricing concessions in 2017. In contrast, 49% are budgeting for service pricing to remain stable, with the balance (51%) preparing for rising service costs.

Exploration. With the U.S. leading the way, exploration spending appears to have rounded the corner and may increase slightly in 2017. Only 20% of the survey respondents plan to decrease exploration capex in 2017, relative to their 2016 budgets, which should be more than offset by the 26% of respondents planning an increase.

REGIONAL BREAKDOWN

North America. The short-cycle nature of the North American oil and gas market set the stage for what was a capex “disappearing act” in 2015 and 2016. Operators reacted swiftly to the price collapse, and the North American market (NAM) experienced the steepest spending decline of all the global regions, falling more than 60%, from the $220-billion peak in 2014 to a mere (estimated) $84 billion in 2016. Canadian capex also was affected by intensified seasonal weakness through the winter drilling months.

At the start of the downturn, in late 2014/early 2015, Canadian operators (mostly comprised of smaller independents) were the first to scale back operations, slashing spending 42% in 2015. U.S. companies followed suit, cutting D&C 35%, as a “lower-for-longer” outlook came into focus. In 2016, NAM operations set a historically low bar for capex, with Canadian companies cutting budgets an additional 36%, while U.S. E&Ps lowered spending an extra 44%. As evidenced by the proportional shift toward extended-reach oil wells (from gas horizontals) over the previous market cycle, spending in the U.S. was buoyed partially by lower break-even shale oil, and perhaps benefitted from steeper service pricing concessions.

U.S. onshore. The Permian core of the U.S. market has garnered the majority of the 2016 NAM D&C spending, with nearly 50% of U.S. oil rigs (the majority of which are extended-reach horizontal rigs) working within 150 mi of Midland, Texas. Outside of West Texas, operators have been slow to add incremental rigs in the other major U.S. shale plays, with 8% of the oil rigs working in the Woodford (SCOOP/STACK), 7% operating in the Bakken, and 7% drilling in the Eagle Ford. However, recent permitting data indicate that spending diaspora may begin to grow outside of the Lone Star State, with many of the other major petro-states approaching year-over-year permitting break-even levels.

Gulf of Mexico. The recent OPEC production deal catalyzed an 8%+ recovery in crude prices, very much in the wheelhouse for unlocking the majority of NAM shales. The deal also offered incremental positivity for the U.S. Gulf of Mexico, which is operating at historic lows in terms of vessel utilization and dayrates. The working rig count seemed to have bottomed some time in third-quarter 2016, with fixtures for both floaters and jackups increasing sequentially for two months in a row in the Gulf. Rig supply has stabilized over the past quarter, as newbuilds stay roughly on pace with rigs being cold-stacked.

Canada. On Nov. 22, the Canadian Association of Oilwell Drilling Contractors released its 2017 drilling forecast, which predicted a 31% increase in the number of wells spudded (4,665 for 2017). While this total is still well below the 10,000-plus wells spudded in 2014, it is an improvement on 2016. Evercore ISI believes this level of drilling will be exceeded, considering the OPEC developments in Vienna, as operators will scramble to add rigs during the “winter projects” drilling season in Canada, to leverage $50-plus oil prices.

The colder weather in Canada will cause muskeg-rich bogs and lakes to freeze over, which will make terrain easier to navigate and will lower logistical costs for oilfield development in several major oil sands basins. In addition, higher oil prices will unlock a greater percentage of the deep Montney oil plays.

Middle East.Evercore ISI now expects spending in the Middle East to have fallen just 6% in 2016, as compared to our prior call for a 7% decline. Looking to 2017, we believe that spending in the region will decline ~3%, due to a 20% decline from PDO (Oman), a 14% cut from ADNOC (UAE), and smaller 3%-to-6% declines from KOC (Kuwait) and QPC (Qatar).

Latin America. This region experienced a significant 36% capex decline from 2015 to 2016, following a 15% step-down from the near-$73-billion peak in 2014. Early 2017 indications point to another steady 13% decline, due to steep declines from PDVSA, Pemex and Petrotrin, offset by a 100%+ spending increase from Ecopetrol.

Russia/FSU. Last year will likely meet our mid-year Russian and FSU projection of 5%+, as the region has proven much more resilient than other geo-markets, considering the dual-threat of depressed prices and EU sanctions through 2015 and 2016. The results are driven primarily by Rosneft’s higher capex levels (the company accounts for nearly 40% of Russian spending, and raised capex 33% in 2016), while Gazprom also increased spending 10%, to build out its natural gas capacity in response to increased European demand.

For 2017, we project another 12% capex build, supported mainly by upstream spending growth from Rosneft and Gazprom (+32% and +29%, respectively), partially offset by spending decreases from Lukoil and Novatek (–7% and –38%, respectively).

Europe. At mid-year, we predicted that European spending would exhibit a moderate, 13% decline in 2016, and that figure has been revised down to a 19% loss, given a string of accelerated budget cuts from the region’s top operators. Eni will likely have reduced 2016 spending 14% year-over-year, while Statoil is on pace for a 25% year-over-year spending decrease. In 2017, we see a slight uptick in European capex.

Asia/Australia. Current estimates for 2016 include a 17% spending cut among Asian and Australian producers, compared to a more optimistic 13% cut at mid-year 2016. Results were driven by unilateral year-over-year budget cuts from CNOOC (–21%), PetroChina (–18%), Petronas (–18%), PTT (–20%), Santos (–41%), Sinopec (–13%) and Woodside (–18). ONGC was the lone operator with flat 2016 capex spending from 2015. In 2017, we expect spending to remain relatively flat (down a slight 2%).

Africa. Halfway through 2016, Evercore ISI projected a 23% decline in upstream African spending. We have since confirmed a 24% capex cut, as NNPC (Nigeria), Sonangol (Angola), and Sonatrach (Algeria) have all decreased 2016 by at least 11% year-over-year. Several seemingly monumental credit events have to fall favorably for these struggling NOCs, to continue operations, but given the forgiveness of global debt markets, and considering the dire need for these countries to replace dwindling production, we predict that 2017 will bring capex stabilization and cash flow growth (with an improved oil price). In the meantime, it is up to the super-majors and other large IOCs to bear the brunt of the upstream spending burden.