Oil at Sub-$50 Puts Projects Worth $1.5 Trillion at Risk

Oil and natural gas exploration and production firms have had a tough year. With crude prices having tanked to the mid-$40 per barrel level from the peaks of over $110 seen last year, profits have almost been wiped off for several of these firms.

The upstream companies have been trying different approaches to handle this commodity price weakness. These initiatives include job cuts, dividend suspensions, restructuring of assets and most importantly, reduction in capital spending.

Several big names from the exploration and production space like Apache Corp. APA, Chesapeake Energy Corporation CHK, and Devon Energy Corporation DVN to name a few, have already announced spending cuts this year.

But Are These Cost Cuts Enough?

A recent report from the research and consultancy firm, Wood Mackenzie, concludes that "while operators are seeking an average cost reduction of 20–30% on projects, supply chain savings through squeezing the service sector will only achieve around 10–15% on average."

Upstream investment has already declined about $220 billion for 2015 and 2016 compared with the estimates prior to the oil price slump. Also, 46 projects have been deferred as a result of the crude price crash.

However, the measures undertaken by these upstream companies do not seem to be enough, at least at the sub-$50 per barrel level. Wood Mackenzie analysts expect projects worth approximately $1.5 trillion (yes, that big a number!) to become unviable with oil unable to break the psychologically important $50 barrier.

The oil and gas industry is quite big and can generally accommodate 40–50 projects every year, worldwide. However, analysts at Wood Mackenzie are apprehensive of this number plunging to a meager six in 2015 and about 10 next year.

With new projects sanctions becoming increasingly hard to come by, pre-sanctioned projects have been receiving a large number of bids from the services industry. This is likely to result in 10–15% supply chain cost savings for the pre-sanctioned offshore projects for operators. Nonetheless, putting undue pressure on the services industry could result in long-term woes when crude prices recover.

So, what should the upstream firms do to make at least some of the projects from the trillion dollar basket feasible? Per Wood Mackenzie, the answer lies in finding smarter ways to work with the services sector. Companies need to work on project optimization, look for new methods of project management and field developments.  

Mr. James Webb, Upstream Research Manager at Wood Mackenzie, concludes that cooperation between operators and services companies will likely be the key driving force in achieving project efficiency. Also, Mr. Webb believes that operators that have a pipeline of projects near sanction will be the winners in this downturn. This is because these companies will be able to reap benefits of the low costs, going forward.

Oil Sector Woes Remain

While the commodity price weakness has resulted in reduced profits throughout the energy sector, the upstream, drilling and services stocks remain the worst affected.

The oil and gas exploration and production industry is expected to witness a decline of nearly 21% in earnings this year, while oilfield services and drilling stocks' profits are likely to plummet 20% and 11%, respectively. Also, the upstream and the oilfield services industries have much weaker Zacks Industry Ranks of 160 and 204, respectively among more than 250 industries. Falling to the bottom end of this ranking hierarchy indicates that the bearish outlook prevails over the industry as a whole, not just over specific stocks.

As such, it would probably be best to steer clear of the Sell-rated (Zacks Ranks #4 and #5) stocks from these industries. Some such stocks are Range Resources Corporation RRC, Southwestern Energy Company SWN Cheniere Energy, Inc. LNG and Emerge Energy Services LP EMES.

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