US E&P Heavyweights Brace for Another Tough Year

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The verdict is in from the US' leading independents: 2016 is going to be every bit as difficult as this year, with low oil prices lingering and natural gas prices remaining stubbornly low. The response from those that have reported third-quarter earnings thus far is that they will largely hunker down accordingly. Spending will fall and production will grow minimally, if at all, as these larger E&Ps exercise more balance sheet conservatism than seen even in a choppy 2015. Some elements of these conservative strategies do vary, however, with firms such as Hess and Anadarko Petroleum seeing an opportunity to invest in select exploration projects through the commodities cycle, while others, including Occidental and ConocoPhillips, insist exploration is not a priority for their increasingly few incoming dollars. Earlier this year, oil appeared primed for a quick recovery, with US benchmark prices rising toward $60 per barrel in late May and early June. But the rebound was short-lived, and since then producers big and small have largely accepted that the current commodity cycle will linger for at least a large portion of next year (EIF Oct.7'15). Marathon Oil made one of the more drastic moves last week, when it announced that it was slashing its dividend and capital spending in the face of low oil and gas prices (EIF May27'15). "We believe it's a time for discipline, continuous cost reduction, sustainable efficiency, maximizing returns and balance sheet protection," Chief Executive Lee Tillman said. The Houston-based producer will cut its quarterly dividend per share from 21¢ to 5¢ -- boosting free cash flow by $425 million per year -- while cutting a further $200 million off its 2015 budget. Marathon meanwhile expects to spend $2.2 billion next year, a 29% reduction from this year's already soft levels. "Management is doing the right things but the business needs higher oil prices to work," Credit Suisse analyst Edward Westlake said in a recent note. He added that while Marathon has a large inventory of low break-even US shale wells in the Eagle Ford of Texas and the Scoop play in Oklahoma, it lacks a position in the more economic Permian Basin. Indeed, the Texas-New Mexico play is exactly where Oxy and Anadarko are focusing their coveted investment dollars in the near term. Oxy CEO Steve Chazen continues to stress the flexible nature of the company's operations in the Permian, while also saying that the firm's quarterly outlays in 2016 will be less than the $1.1 billion to $1.2 billion planned for the fourth quarter (EIF May20'15). Part of that reduction is due to cost deflation in a low oil price environment, but the firm is also winding down spending on the Al-Hosn gas project in the Middle East and on an ethylene cracker in the US. Similarly, Conoco is ramping down its massive capital spending campaign on a host of projects it is bringing on line this year and next (EIF Apr.15'15). The world's largest independent E&P continues to trim its capital spending this year -- now down to $10.2 billion -- and sees it likely moving lower next year as it pushes for cash-flow neutrality by 2017. Unlike its smaller peers, Conoco's production should grow significantly despite these cuts, thanks to large contributions from Australia Pacific LNG and its Surmont 2 oil sands project in Canada. "With first oil from Surmont in [the third quarter] and APLNG cargoes on track for year-end 2015, we see project execution driving a fast-track narrowing of the funding gap," says Deutsche Bank analyst Ryan Todd. With bulky spending projects behind them, Conoco and Oxy have said they aren't incentivized to engage in costly exploration programs for the time being. In fact, Conoco has decided to exit deepwater exploration altogether after it finishes up its 2015-16 queue of drilling -- a stark reversal in strategy for a firm that had actively built up its deepwater exploration capabilities in recent years. For its part, Oxy is also working to reduce its exposure to its more troubled assets in the Middle East, mainly Libya, Iraq, Bahrain and Yemen (EIF Dec.3'14). "These actions will improve the profitability and cash flow of our Middle East business as we focus on our core assets in Abu Dhabi, Qatar and Oman," said Oxy's senior executive vice president and incoming CEO, Vicki Hollub. On the other hand, Hess and Anadarko have said they see the perceived bottom of the price cycle as a good opportunity to invest in exploration. Hess, which boasts ample liquidity after striking a deal for a midstream joint venture in the Bakken tight oil play in North Dakota, said it plans to use operating cash flows and cash on hand to fund growth investments, including exploration and appraisal activities. Westlake, of Credit Suisse, recently praised Anadarko's value-over-volume strategy and its continued exploration, saying that finding low-cost hydrocarbons and then monetizing those discoveries is a better strategy than "drilling the best rocks" in its portfolio when commodities are still stumbling. Anadarko is guiding mostly flat year-over-year production in 2016 on a reduced capital spending budget. "We just think that the better allocation of capital today is to focus on building that kind of longer term value and not accelerating growth -- selling your best assets into a relatively lower margin environment," said Chief Financial Officer Bob Gwin. Another area where Conoco has said it would scale back is in North American natural gas, reflecting a growing trend among US energy producers. A glance at leading independents' production shows that natural gas production is on the decline for many, being replaced by rising oil output. For 2016, this could result in oil production jumping even as overall volumes remain stagnant or fall, as natural gas volumes slide lower. Anadarko, for instance, reported that its US lower 48 crude oil output jumped 16,000 barrels per day year-over-year in the third quarter, while its gas production was down 265 million cubic feet per day. For Conoco, global oil output was up 7.5% during the most recent quarter, while natural gas was up a more modest 2%, and they expect the gap to widen. CFO Jeff Sheets told analysts last week that natural gas, like deepwater exploration, just can't compete for investment currently. So what does this say about how operators view natural gas? Even in a mid-$40/bbl environment, crude oil is still viewed as a better investment than natural gas (EIF Jan.7'15).

Exploration, Offshore Oil and Gas, Shale
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