I’m no great bull for oil. I think the market dynamics are hazardous for oil stocks specifically and oil producers generally. Go above $50 a barrel and the US unconventional oil and gas guys will nail you. Go below $40 and hardly anyone outside of the Gulf will be able to survive intact for extended periods of time. Call it the immovable forces of capitalism on one side (shale) and state largesse/public sector mismanagement (OPEC) on the other. My hunch is that we’ll see oil trade in a $40 to $60 a barrel range for quite some time.
The key dynamic for me is the US. Here we see the capital markets plugged into capex formation in a direct linear fashion. Bond investors will happily give money to the right businesses that can produce oil and gas ever more cheaply. Cut costs and you get more cash. And guess what competitive dynamic that unleashes? You guessed it, cheaper energy. No matter that within 20 years much of that oil and gas might have to stay in the ground because of climate change and the electric revolution. Capitalism doesn’t think that far ahead!
So given this (desperate for OPEC) background, I thought a note from analysts at Goldman Sachs warranted attention. Apparently, the pointy heads of the US investment bank had popped down for a jolly to Texas to meet their favoured unconventional plays. Their message was simple and unambiguous. Beware OPEC!
Anyway here’s the note from last week from GS.
“Oil macro: Insufficient fear, for now, …sustained $45 a key threshold
Producers are not yet blinking in response to $45-$50 oil. While E&Ps typically respond to prices of two months ago instead of two weeks ago, few appeared on track to consider reducing 2017 activity/capex plans. Most concerning were comments from some weaker balance sheet producers that it is better from a leverage perspective to spend capital, even if above cash flow, to raise base EBITDA. In our view, E&Ps travel as a herd and no one want to be the first to scale back. However, once one company scales back, others may follow. Sustained $45 is a key threshold price.
Shale macro: Bullish productivity gains, but some come with greater decline rates later on
Shale productivity gains continue to lower managements’ views of what oil price they need to drill. E&Ps recognised that completions costs are rising, but most indicated they are sufficiently offset by efficiency/productivity gains, so there was little discussion of capex budgets being pushed higher for cyclical reasons. Productivity gains — driven by longer horizontal wells and fracking with more horsepower/sand — still have room to run. More intense fracking over time is likely to raise decline rates as some of the up-front benefits to well performance represents accelerated recovery.
Stocks: Reiterate Buy on CLR, NFX, NBL
Industry commentary from the trip is unlikely to help already-low investor sentiment, but at the same time continues to favor companies with capital-efficient growth and disproportionate productivity gains at $50/bbl oil. We remain Buy rated on CLR: Bakken productivity/margin gains, capex/ cash flow discipline, strong corporate returns, commitment to debt reduction and STACK resource expansion can raise through-the-cycle investor interest. We stay Buy rated on NFX/NBL as concerns over NFX’s production ramp and NBL’s Permian costs/execution seem overdone. Incrementally, CRZO’s abandoned pursuit of an offsetting Permian acquisition could drive bear capitulation.