Shale Industry Cuts Rigs As Shareholder Pressure Mounts

Friday October 13, 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. Energy stocks underperforming

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- Investors are losing patience with the shale industry, which has posted enormous production growth rates for years, but has come up short on profits.
- The growth-at-all-costs business model is suddenly being challenged by a wide range of investors, who are demanding that shale drillers slowdown and focus on returns rather than higher levels of drilling.
- The backdrop to this shift in shareholder sentiment is some of the worst returns on investment. The energy sector has dramatically underperformed the broader S&P 500.
- "E&P (shale growth) model is capital destructive," said Morgan Stanley analyst Evan Calio.
- Analysts view Anadarko Petroleum's (NYSE: APC) September decision to buy back up to $2.5 billion in shares - and the subsequent spike in its share price - as a sign of changing times.

2. Drilling activity declines, especially for indebted companies

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- The U.S. shale industry has suffered some hiccups lately, even as oil prices recently jumped back above $50 per barrel.
- The rig count has plateaued, but companies of different sizes have responded differently.
- Private producers with no access to external funding, according to Goldman Sachs, have pared back drilling activity. Horizontal rigs among publicly-traded high-yield shale drillers has dropped in the past month as well.
- Integrated oil companies, such as ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX), are still implemented some growth plans. That is consistent with their strategies of trimming spending on risky offshore areas and focusing more on shale.
- But shareholder pressure is forcing a lot of small and medium-sized drillers to focus on returns rather than growth.

3. Iraq and Iran fill Saudi void

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- Saudi Arabia has stepped up its efforts at tightening the oil market by focusing on lower oil exports rather than simply cutting production.
- But cutting shipments has left a void, which is happily being filled by Saudi's peers. Iraq exported 3.98 mb/d in September, the highest total this year. Iran's oil exports jumped to 2.28 mb/d, the largest total since February, according to Bloomberg.
- The rising totals from Iraq and Iran come as Saudi exports dropped to 6.68 mb/d, its second lowest figure this year.
- Saudi Arabia is desperate for higher oil prices, but it is wary of losing market share.
- The shift is even more dramatic in key markets. The U.S. imported 871,000 bpd from Iraq in September, more than Saudi Arabia for the second consecutive month.

4. Oil inventories falling in Europe

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- The IEA said this week that the oil market continues to make substantial progress, citing falling global inventories.
- The key oil hub of Amsterdam, Rotterdam and Antwerp (ARA) has seen crude inventories fall to their lowest level since February 2015. Diesel in particular has seen much tighter conditions due to strong demand.
- But the bullishness could be regional - Hurricane Harvey disrupted refining and exports from the U.S., putting greater strain on Europe. Those effects are only temporary.
- Still, stocks are falling in a growing number of places, including in floating and independent storage. OECD inventories are now only 170 million barrels above the five-year average, down substantially from 318 million barrels earlier this year.

5. Trump targets Iran's oil

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- President Trump is expected to decertify the Iran nuclear deal on Friday. The move raises questions about what will happen to Iran's oil exports.
- Iran was exporting less than 1.5 mb/d before sanctions were lifted in early 2016. Exports quickly ramped up by almost double - and Iran currently exports about 2.3 mb/d.
- The U.S. will not have the same level of support to reinstitute sanctions on Iran. If it decides to go that route, Iran will probably be able to weather the storm and keep exports pretty close to current levels.
- But sanctions could scare away investment into new projects. Total SA (NYSE: TOT) has the most to lose. Total signed a major deal with Iran to develop part of the South Pars gas field, the largest natural gas field in the world.

6. Canadian oil price run about to end

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- Canada's oil producers have enjoyed a price run this year, relieving some pressure on high cost producers.
- The benchmark price Western Canadian Select (WCS) spiked this year because heavy crude outages in places like Mexico and Venezuela put a premium on Canada's heavy oil. The discount that WCS sees relative to WTI narrowed sharply from $17 per barrel in January to just $11 more recently.
- However, a wave of new Canadian supply could push WCS down again. Suncor Energy (NYSE: SU) is about to bring 175,000 bpd of new production online from its Fort Hills oil sands mine. The strain on pipelines will likely force deeper discounts for WCS.
- The WCS discount could widen to $12 to $15 per barrel by the first quarter, according to Carl Evans, an analyst at Genscape Inc.

7. Surplus to return in 2018

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- Goldman Sachs predicts that crude oil inventories fall at a rate of nearly 0.8 mb/d in the third quarter, a huge decline that resulted in a surge of optimism regarding oil prices.
- But that was probably "as good as it gets" in terms of movement on inventories. The stock decline will then narrow to just 0.18 mb/d in the fourth quarter before flipping into a surplus of 0.06 mb/d early next year. The IEA has different figures, but they come to a similar conclusion regarding peak drawdowns in the third quarter.
- The third quarter saw such a large supply deficit because of a few factors that might prove to be temporary, such as an interruption of shale production from Hurricane Harvey, robust demand that will soon taper off, and high OPEC compliance that is now showing signs of weakness.
- Obviously, much depends on what OPEC decides at its upcoming meeting in November, but the sharp price increases from September will be difficult to replicate.

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