Investment Bank Analyst Discusses Slide in Crude Prices

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“May we live in interesting times,” Bill Marko, managing director at Jefferies & Co., began his presentation Wednesday on the state of the oil and gas market at the IPAA/TIPRO Leaders in Industry luncheon in Houston. Marko’s talk included a brief overview of mergers and acquisitions amid the steep drop in crude oil prices in the past six months.

To be sure, the turnaround in the market has been dizzying. Just a few months ago, the oil and gas industry was “running at the red line,” Marko said. Everything was moving as fast as it could go, rig counts were at a peak of around 1,900 in the United States, and companies were limited only by available capital and execution.

Fast-forward a few months and prices are settling for less than half their 2014 peak settle. Rig counts have begun to wane, capital expenditures are being revised, and talk of the oil bust of the 1980s is beginning to make the rounds. Much has changed, but one constant is execution efficiency, and managing supply costs, Marko said. Companies are always challenged managing costs, and it is more important now than ever, he noted. 

Alas, for those who showed up at the event looking for a sign of hope that the market will quickly reverse direction and begin climbing again, Marko did not give them one.

“It’s going to be a bumpy ride on oil. I think this environment is going to last a long time. I would characterize it [by saying that] the Saudis can probably hold their breath as long as anybody. It’s going to be a tug of war with OPEC [the Organization of the Petroleum Exporting Countries], and within OPEC, between people who can live with lower-priced oil and people who can’t,” he said.

In the United States, the situation might not be as bleak as it is currently being portrayed. The oil and gas industry is a $100 billion-a-year industry, Marko noted, and it is facing $5 to $10-million decisions, and not billion-dollar decisions. 

“You can add rigs or you can cut rigs pretty quickly. Companies are challenged whether oil is $100 or $50. They are challenged on execution efficiency, operating costs, capital costs, how to do things smarter and cheaper – that sort of thing. It’s really about supply costs now – how can you supply it and at what price.”

The reversal in crude oil prices will not hit everyone equally. Among those who will be hit the hardest are the service companies, who will suffer during the downturn as producers pressure them to cut costs, Marko noted.

As for where prices are headed, Marko was not upbeat, but he left the door open a crack.

“I am prepared to live with $60 to $70 oil in the near-term, and I’ll be vague about what the ‘near-term’ is, but it’s certainly this year,” he said adding that he was hopeful of $70 to $80 oil, absent any disruptions in the business. 

While prices have probably fallen quicker than anyone could have foreseen, the industry probably knew, or should have known, that a market slide was coming, according to Marko. Looking at the futures curves for the end of the last four years, he noted that the market was “$100 oil heading to $80, $100 oil heading to $75, $100 oil heading to $70, and then boom, the bubble burst.”

That makes the years of $100 oil “a real blessing,” he added.

Oil prices have faltered in large part because of a glut of supply, relative to current demand. Regarding when the various OPEC countries might agree to cut production to stop the price slide, much will depend on how they fare with prices that are less than half of what they were in June. For example, Iran, Marko noted, planned for oil revenues that peaked at $140/bbl, and could feel the shortfall soon. However, Saudi Arabia’s and the United Arab Emirates’ sovereign well fund size was $773 billion, thus allowing them to “hold their breath a really long time. The Saudis are in it for the long haul.”

How different U.S. companies are faring amid $50 oil depends on when they began operating, where they are operating, and how large they are. Even within the same formation, there can be a large disparity in costs and production, Marko said, adding that some formations have not seen the reduction in activity that other formations have.

Marko noted that the rig count has begun to wane in recent weeks. However, he said it will probably be another three to six months before the drop in rig counts really begins to show up, adding that as many as 300 to 500 rigs could go down before the market begins to recover.

Permitting has dropped about 35 percent in recent months, giving some indication of what is in store for the industry. However, as other analysts have noted, existing wells will still continue, despite the drop in new wells. 

 

 

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