As third quarter earnings continue at full steam, it’s hard to imagine a world where the US and global oil markets are able to re-balance anytime in the near future. Producers like Noble, Anadarko, and Devon have all reported that they are able to do more with less and beat their productions targets while still coming in on or under capital budgets. However, these same producers and others in the US have also realized that they must learn to exist within cash flow if they are to weather this price cycle and the results are trickling through the system. In the global oil market, it is now up to North America, with its free and liquid capital markets, to act as the new swing supply source which requires employing capital stewardship and therefore reducing activity to meet cash flow.
Cash flow from operations comes from the sale of oil, gas, and NGLs. However, oil is the largest contributor and with its price collapse, monthly cash flow is a meager shadow of itself at $5 B today, only 25% of its almost $21 B peak in June 2014. Note that this model does not factor in hedges and assumes E&Ps get spot prices minus royalties, severance taxes, transport costs, LOE, etc. for their production.
This has resulted in a slowdown in drilling, albeit on a 2-3 month lag to cash flow and price declines. In the figure below, the red line shows that cash flow from operations tanked immediately with prices, while the drop in rigs and well counts has been relatively less severe and lagged by several months. The key takeaway, however, is that cash flow, rigs, and wells have all started to level out. This, paired with the idea that if cash flow is at its current level of $5 B per month and an average US well costs $6 MM to drill and complete, then assuming that all cash is spent on D&C capital for horizontal wells, the industry can afford to drill roughly 833 wells per month at current pricing. As of October, 1,042 horizontal wells were drilled across the US, which is not very far from the 833 estimated to create a balanced cash flow scenario. This suggests that producers are starting to align drilling with cash flow.
Now, expanding this to look at the impact on production, BTU Analytics estimates that production has already fallen 300 Mb/d (US L48) from its peak and will continue to decline an additional 100 Mb/d into 2016. While market sentiment is still extremely bearish crude prices in 2016, BTU Analytics believes that this supply response is enough to paint the picture of a balanced market at the end of 2016. Using IEA’s global demand forecast (95.7 MMb/d average 2016), holding Saudi, Iraq and other OPEC production flat to 2Q 2015 levels (38.3 MMb/d), and factoring in modest declines in other nations like Russia and Canada, the global market goes from being long as much as 2.4 MMb/d in 2Q 2015 to being long only 0.5 MMb/d in 4Q 2016. This analysis factors in 0.4 MMb/d of growth from Iran in 2Q 2016 and an additional 0.2 MMb/d in 3Q 2016.
In this case, prices can potentially recover at the end of 2016 and there is enough incremental global demand growth for US production to rebound slightly at the end of the year from its trough. While this is not a recovery to the hey-days of $100 crude, producers with the best acreage, strong balance sheets, and capital discipline may be able to look forward to $60 crude by the end of next year. To hear more about our outlook for production in the US, REGISTER HERE for our complimentary webinar entitled, Bringing Clarity to Production Forecasting and Completions Activity.