The oil majors and shale E&Ps will soon begin publishing second quarter results, which will round out a picture of how the industry fared in the first half of 2019.
Shale drillers find themselves at a troubling crossroads. Since 2012, North American oil and gas companies have eviscerated $187 billion in cash flow. Production has soared but the profits have not materialized. For years investors shoveled more capital their way, and the money was dutifully injected into the ground. More oil came up, but again, the financial returns did not follow.
Wall Street is losing patience. “Investor sentiment continues to be negative heading into 2Q,” Goldman Sachs wrote in a note. “Meetings with investors this week indicated that generalist portfolio managers are largely hiding and not seeking.”
By “hiding,” the bank said that investors were sticking with midstream and integrated companies, and also clean energy. They are “not seeking” oilfield services companies, which are particularly out of favor. That doesn’t mean that they are shunning shale altogether, but Goldman’s assessment was that most investors are sticking with “quality,” and the bank cited EOG Resources, Pioneer Natural Resources, as well as the majors, including Chevron and ExxonMobil, as examples.
More notably, Goldman said that while analysts have a wide variety of opinions on things like oil production growth levels, “increasingly specialists are not debating whether stocks go up or down but are flat vs. go down.” In other words, if shale drillers do everything right – they keep capex in check and still produce as much as expected – their share prices will merely stay flat.
On the other hand, if companies need fresh capital injections, decide to spend more, or report disappointing production figures, then their stocks will sink, Goldman warned. There isn’t a huge upside to shale stocks; at best they will tread water.
To be sure, not all investors are of this view. Some see the forthcoming interest rate cut from the U.S. Federal Reserve, slowing oil production growth, “broad economic strength” and higher demand as bullish factors for oil prices and for stocks in the sector.
Goldman said that investors will particularly watch “whether companies that spend meaningfully more than 50% of annual budget in 1H will meaningfully reduce activity during 2H19 and whether this will be a drag on 1H20 production levels.” Also, they will focus on “shale decline rates and the impact on 2020 capex/cash flow.”
The industry is in the midst of a wave of consolidation. The decision by Callon Petroleum to buyCarrizo Oil & Gas is a telling example of the trouble that some shale drillers find themselves in. As Liam Denning at Bloomberg Opinion noted, Carrizo’s decision to sell out at a time when its share price was at a multi-year low suggests that it saw little chance that it would be able to drill its way out of its financial predicament. That’s a departure from the past, when companies sought fresh capital and another round of drilling.
At the same time, Callon’s shareholders weren’t pleased either, with its share down 15 percent on Monday after the news was announced. Shareholders have punished companies that take on new spending. The same dynamic was apparent when Occidental Petroleum succeeded in its quest to buy Anadarko Petroleum two months ago.
Unprofitable shale drillers are likely going to head for the exits one way or another, and investors are calling for consolidation, but the path forward is going to be rocky.
In the meantime, most energy forecasters still see huge increases in supply going forward. The IEA, EIA and even OPEC see trouble ahead for the market, with the “call on OPEC” declining in 2020 as yet another wave of shale production comes online. New Permian pipelines set to start up later this year will pave the way for more output.
However, a surge in production, and another supply glut, will not help out shale E&Ps or their tormented shareholders.
By Nick Cunningham of Oilprice.com