If we told you that there was one variable that could swing our US production forecast 10 Bcf/d and 2 MMb/d over the next two years, you would want to know what that variable was. The question of whether US E&P companies need to fund their own drilling is that consequential.
Our models have always assumed that investors will continue to allow US E&Ps to outspend cash flow. This is because while investors in the E&P sector give lip service to the sector’s lack of capital discipline, they have historically awarded higher multiples and praise to companies focused on production growth. But it appears that the tide may be turning.
Year to date, some of the top performing stocks in the E&P sector are companies that aren’t outspending cash flow, as shown in the chart below.
If the trend continues, what could it mean to US production? We can illustrate the impact with BTU Analytics’ two proprietary production models provided as part of our Upstream Outlook service.
Our two models approach US production in very different ways. Our base case model is rooted in thinking through the implications of today’s activity in the field. Our cash flow model is a conceptual model based on financial and economic theory. We jokingly refer to them as “the way the market really works” versus “the way the market should work”.
Our base case model considers IP rates, the number of wells drilled and turned to sales each month, the impact of DUCs and spud-to-sales timing in addition to infrastructure constraints in over 90 areas of the country. This model is rooted in reality—the activity and production in the near-term forecast is based on current activity. As we progress through the forecast period, activity in each area moves toward levels that balance the US market over time, based on factors including economics and infrastructure utilization.
Our cash flow model is more conceptual. It assumes that the amount of activity we witness in the field should be generally tied to the amount of cash flow being produced by wells that are currently online. The primary source of capital for established E&Ps is operational cash flow, so this model starts with a closed system where our primary input is price, and the model will output the amount of activity and production associated with that price curve. From there we can make adjustments for cash leakage or outside capital entering the system.
The models give us much different pictures of what US production could be. While our base case grows significantly over the next few years based on the assumption that operational momentum will carry forward and outside capital will remain available to Permian and Northeast producers, our cash flow model says that oil production will stay flat while gas production will decline if E&Ps must limit activity to what can be drilled within cash flow.
While capital discipline might be the topic du jour, it will be interesting to see how long the market will remain focused, particularly given the number of changes coming to both the oil and gas markets through the winter and spring. For our evolving thoughts on all trends impacting US production, or for more information on our production modeling tools, inquire about BTU’s Upstream Outlook service or Production Forecasting Tool.