Things are looking up in Shalelandia these days. Oil prices, despite the most recent drop, have stayed close to $50 a barrel. Rig-counts and production are rising. Even Saudi Arabia is looking discombobulated.
Lest we forget, though, the chief reason things are looking up is because E&P companies fell way down.
Back in October, Gadfly surveyed the financial performance of 11 of the biggest oil and gas producers focused on North America. Now that they have all filed their 10-Ks for 2016, we can see how they fared in the very depths of the oil crash.
The first thing to note is that the sector’s almost clichéd resilience cracked in one respect: Output broke a pattern of double-digit growth and actually declined overall. Only four of the 11 companies managed to raise their production: Concho Resources Inc., EQT Corp., Pioneer Natural Resources Co. and Range Resources Corp.
That slight dip in crude oil production hurt the most. The E&P sector has been shifting toward higher-value oil over natural gas, where prices crashed and have stayed low. Crude oil and other liquids are now almost 44% of the mix, up from 23% in 2009.
This shift in the production mix has been crucial to offsetting some of the pressure on realized prices. While Nymex crude oil might be trading at around $50 a barrel, E&P companies selling a mix of products in different regional markets realize very different actual prices per barrel of oil equivalent. Selling more oil helps, but it couldn’t fully offset the carnage of the past two years.
Oil-weighted companies such as Pioneer enjoyed the relative sanctuary of realized prices in the upper $20s, while at Southwestern Energy Co., producing 90% natural gas, they actually fell below $10 (before hedging effects).
As you might imagine, this didn’t do wonders for margins per barrel. The E&P companies report these in different ways. Gadfly calculates an adjusted production cost per barrel of oil equivalent, including not just costs directly involved in producing oil and gas, but also the non-income taxes, general and administrative and interest costs reported in the companies’ filings. It’s a more conservative measure that recognizes the corporate overhead each barrel must support; after all, you buy shares in a company, not a set of wells.
Comparing these to realized prices, margins per barrel plummeted by almost 75% between 2014 and 2016.
None of the 11 companies actually tipped into negative margins, although, on Gadfly’s methodology, Southwestern’s and EQT’s fell to a buck or less.
That the group’s output fell by less than 2% in 2016 in the face of such a collapse in realized revenue and profits is a testament to its collective — yes — resilience.
But the foundation of that resilience has been access to U.S. capital markets. While net debt in absolute terms actually fell between 2014 and 2016, aggregate leverage for the group jumped from 1.3 times trailing Ebitda in 2014 to 10.4 times in 2016, according to figures compiled by Bloomberg. Only the remarkable faith of, in particular, equity markets in a brighter future has prevented even more of a shake-out in the industry.
Indeed, it is this dynamic that has so perturbed Saudi Arabia in the past couple of weeks.
On the one hand, it would like to finish the job of squeezing higher-cost rivals out of the oil market; our analysis shows it was clearly making progress on that front in 2016. On the other, though, an IPO of Saudi Aramco is supposedly not far off. So its owner, the Saudi Arabian government, is now compelled to keep the equity market feeling good about oil’s future.
The unwelcome side effect? Suffering rivals in the shale patch can free-ride on such optimism to repair themselves and resume growing.