Bad Year For Shale Stocks Despite Rebound

Friday August 11, 2016

In the latest edition of the Numbers Report, we’ll take a look at some of the most interesting figures put out this week in the energy sector. Each week we’ll dig into some data and provide a bit of explanation on what drives the numbers.

Let’s take a look.

1. Disappearing contango

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- The oil futures market has been in contango pretty much since early 2015. A contango – when front-month oil futures trade at a discount to futures further out – suggests a state of oversupply.
- But the contango has narrowed substantially recently, with Brent tipping slightly into a state of backwardation – in which front-month contracts trade at a premium to longer-dated futures.
- The reason this is important is that the futures curve is telling us that the oil market is getting tighter. And the backwardation itself will help accelerate that tightening by taking away the incentive to store oil.
- Backwardation will also make hedging by shale players less attractive since 2018 prices could fall below today’s spot price.
- In summary, the sudden narrowing of the contango, and the possibility of backwardation, is a leading indicator of higher oil prices ahead.

2. Bad year for E&P stocks continues

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- It has been a rough year for energy investors, and the poor performance of U.S. shale companies continues, with a steep selloff this month.
- The most recent troubles came largely from Pioneer Natural Resources (NYSE: PXD), considered one of the top shale drillers in the Permian.
- Pioneer reported problems with some of its wells in the Permian, noting pressure problems and a higher natural gas-to-oil ratio in its production than expected, normally a sign that a well is aging. The company had to lower its production guidance for the rest of the year.
- This spooked investors, who thought one of the best companies in the best shale basin was untouchable. Pioneer’s share price is down more than 15 percent in the past 10 days.
- If Pioneer’s troubles are a sign of problems in the Permian, then the shale complex could be much less attractive to investors than previously thought. Goldman Sachs said that it fielded calls from investors looking to “re-allocate capital” elsewhere.

3. Shale industry burning cash

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- The shale industry has been built on excitement and expectations of growth. But drillers have been posting negative cash flow for years, both when oil traded at $100 per barrel, and even today at $50 per barrel, despite boasts of efficiencies and low breakeven prices.
- A survey of 33 E&Ps by Bloomberg finds a combined negative cash flow figure in the last 12 months approaching $18 billion.
- And in the past year, even the Permian producers – thought to be the strongest – burned through $11.5 billion.
- The reason the industry continues to grow is because of the generosity of Wall Street. Equity issuance has climbed steeply in recent years, spiking in 2016 in particular.
- Thus far, the cash flow problems have not caught up with the industry, as everyone is betting on ongoing growth projections.

4. International companies withdraw workers from Venezuela

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- A number of international oil companies announced that they were pulling their workers from the increasingly unstable situation in Venezuela. The calls came from Repsol (BME: REP), Chevron (NYSE: CVX), Total (NYSE: TOT) and Statoil (NYSE: STO), some of which left behind a skeleton crew.
- It is not clear at this point if the withdrawals of personnel will affect oil production.
- Repsol has the most to lose out of the group, with 10 percent of its oil production coming from Venezuela.
- Of course, Venezuela is highly dependent on oil – 95 percent of its export revenues comes from crude.
- The companies said that they are willing to return their workers if the security situation improves, but for now, that appears unlikely.

5. Suncor still making oil sands work

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- Suncor Energy (NYSE: SU), Canada’s largest oil sands producer, has bucked the trend of pulling out of costly oil sands projects over the past few years. Several oil majors have sold off assets in Alberta and left town, including Royal Dutch Shell (NYSE: RDS.A), ExxonMobil (NYSE: XOM), ConocoPhillips (NYSE: COP), Marathon Oil (NYSE: MRO). The sales topped $23 billion.
- But Suncor has done the opposite, increasing stakes rather than decreasing them.
- While starting a new oil sands project is prohibitively expensive at today’s oil price, Suncor has long-lived assets already online.
- Suncor is expected to take in more than $2.5 billion in free cash flow this year, a figure that could swell to $4 billion in 2018.
- Suncor will probably defer more massive investments, being content to take in cash and dish it out to shareholders.

6. Shale breaks even at $50

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- The ultimate breakeven price for the shale industry has been one of the most discussed themes of the past few years. The exact price that turned shale growth on and off has been critical to the assumptions of OPEC, Wall Street, and the price of oil.
- With several years of evidence now, it appears that $50 per barrel is as close as we can get to the inflection point for shale, according to Reuters.
- 15 of the largest shale producers had net losses of $470 million in the second quarter, when WTI averaged $48 per barrel.
- That is an improvement over previous quarters, even when the oil price wasn’t all that different, suggesting cost cutting has worked.
- Prices much below $50 per barrel will idle rigs and lead to declining production. Prices over $50 will lead to growth and profits.
- Breakeven prices vary depending on the company, but in the aggregate, the industry needs $50 per barrel to breakeven and keep production up.

7. Metal exploration at 7-year high

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- Metal prices have jumped to multi-year highs, leading to a surge in exploration.
- According to data from S&P Global Market Intelligence, and cited by Bloomberg, global metals drilling climbed in the second quarter, the fifth consecutive quarter of expansion.
- Some of the most intense interest is for lithium in Argentina, and copper and gold in Ecuador and Chile.
- “Activity has picked up over the last two months,” Ronald Ambler, CEO of AC Perforaciones SA, told Bloomberg. “Companies are starting to get out there to explore again.”
- “The LMEX base metals index is having its best start of a year since 2009,” Bloomberg says.

That’s it for this week’s Numbers Report. Thanks for reading, and we’ll see you next week.