Can U.S. Shale Rebound?

1. Upside potential for beaten-down energy stocks

- Oil and gas markets are far from healthy, but with crude prices stable and natural gas prices on the rise, drilling and completion activity could grind higher, according to Morgan Stanley.

- Capex will likely remain flat in 2021, but will increase in 2022 and 2023, the bank believes.

- Key risks to the oilfield services sector include pandemic-related shutdowns, election risks and OPEC behavior. But upside risk includes the possibility of industry consolidation, which would improve supply-side dynamics and oilfield services pricing.

- Morgan Stanley revised up its EBITDA estimates by 4 percent across its coverage area, with top picks in the oilfield services segment including Liberty Oilfield Services Inc (NYSE: LBRT), Nextier Oilfield Solutions (NYSE: NEX) and Cactus Inc (NYSE: WHD). LBRT is up 46 percent since announcing its purchase of Schlumberger’s (NYSE: SLB) OneStim business in September.

2. Demand concerns reemerge as covid cases soar

- Global oil demand rose rapidly between April and July, increasing by 14.7 mb/d from the low point. However, as of July, demand was still down 8.2 mb/d from a year-ago levels.

- Preliminary data suggests that demand increased in August and slightly in September.

- However, mobility data shows that the end of summer holidays and the surging cases of Covid-19 in many countries has more recently led to a decline in demand.

- “A second wave of Covid-19 cases and new movement restrictions are now slowing demand growth,” the IEA wrote in its Oil Market Report. The IEA kept its demand forecast for 2020 at 91.7 mb/d, down 8.4 mb/d from 2019.

- For 2021, the agency sees demand rising to 97.2 mb/d, still below pre-pandemic levels.

3. Future value of oil fields slashed

- The pandemic has slashed the net present value of oil fields around the world. The crisis has cut demand forecasts not just for 2020, but for the years ahead. Lower demand means lower prices, which means lower value for reserves.

- The IEA estimates at 17 percent reduction in the value of future net income for publicly-listed oil and gas companies.

- But that is under an industry-friendly scenario. A separate scenario that incorporates more aggressive climate policy (sustainable development scenario) eats in oil industry value by even more – a further reduction of 30 percent.

- However, the sector has lost 40 percent over the past year, which arguably suggests that markets have already priced in some of this climate risk.

4. Can U.S. shale rebound?

- The hurdles facing U.S. shale drillers appear more challenging than ever. Not only are oil prices stuck at around $40 per barrel – a level at which few companies can turn a profit – but investment trends are turning against them.

- With investors increasingly skeptical, the cost of capital is on the rise. The debt weighted average cost of capital for tight oil operators has climbed from around 8 percent in recent years to over 12 percent in 2020, which translates into an increase unit cost of about $5 per barrel, according to the IEA.

- The agency says that shale production may rebound to pre-pandemic levels by 2022, although the outlook is highly dependent on how much money is funneled back into drilling. Investment in drilling stood at about $100 billion in 2018-2019, but is expected to collapse to $45 billion in 2020.

- The IEA’s central scenario has spending rebounding to $85 billion over the next ten years – below pre-pandemic levels – but that remains highly uncertain. Tight-fisted investors and low prices could keep spending closer to 2020 levels for the rest of the decade.

5. Deep contraction in oil and gas employment

- The U.S. oil, natural gas, and chemical industries employed close to 1.5 million people at its peak during the 2008 boom.

- The 2014-2016 downturn saw layoffs of about 200,000 people. Not everyone was hired back when drilling resumed.

- The most recent bust has also been severe. About 107,000 jobs were eliminated between March and August 2020.

- Unlike past downturns, which saw cyclical effects in hiring, the oil and gas industry is now in a “great compression,” a study from Deloitte finds.

- Roughly 70 percent of laid-off workers will not be rehired, the firm estimates.

6. China’s buying spree not over yet

- “Currently, oil demand is driven primarily by China,” Commerzbank wrote in a note this week.

- China’s oil imports rose to 11.8 mb/d in September, up 2 percent from a month earlier.

- For weeks, analysts had expected a slowdown in imports in September, but the end of the buying spree has not arrived.

- China’s oil imports are up 12.7 percent year-on-year in the first nine months of 2020, a staggering figure given the pandemic-induced downturn.

- With that said, China cannot alone offset headwinds in the market. “We therefore expect oil prices to fall further,” Commerzbank said.

7. Exxon’s multi-year underperformance

- Goldman Sachs upgraded ExxonMobil (NYSE: XOM) from Sell to Neutral on October 12, after having cut the company to Sell back in February.

- ExxonMobil has underperformed Chevron (NYSE: CVX) for several years due to weakening refining fundamentals, concerns about dividend sustainability, higher debt, skepticism about aggressive spending plans, and lack of attractive growth prospects, according to Goldman Sachs.

- Exxon underperformed Chevron by 38 percent since 2016.

- The concerns are “fundamentally justified,” the bank says, but they are more or less priced in at this point. Having been beaten down, the stock price has less room to fall.

- Meanwhile, a separate report from IEEFA documents the many missteps by ExxonMobil and CEO Darren Woods over the past few years, saying the oil major has fallen from “industry leader to laggard.”