Review of US onshore - Inventories, rig productivity and production rates

by Will Forbes

Stocks

The slow down in the growth of US crude inventories has continued this week, with stocks starting to flatten out. At some point the sharp cut in rig count was going to have an effect, and this is now actually starting to be felt.

Source: EIA

The crude stocks are still at record highs though.

Source: EIA

Crude stocks levels are not paralleled by inventories of gasoline, distillate or other products. Gasoline and distillate are very close to 5-year average ranges for this time of year.

Rig productivity and outlook for oil production
While the rig count has fallen, rig productivity has increased markedly. Notably, the Permian region has seen a spike in the rates in April and May, with rates increasing from 200bopd in January to 265bopd in May. We will watch the next few data points in coming months to see how this develops. The Permian currently accounts for 2.0mmbd or about 36% of US onshore production so this is not an immaterial data point.

Source: DPR

Elsewhere, the rate of increase in rig productivity is now normalising with average increases of c.5% (per month) across the regions. It is not hard to appreciate that growth rates of 5% per month have had a significant offsetting effect despite the drastic reduction in rig count since late 2014.

Source: DPR

How much of this growth rate is due to better completion techniques, or increased concentration on sweet spot areas need to be better understood, but at some point these growth rates will slow and eventually flatten out. How long this takes makes a significant difference to the overall production story.

Effect on US production

Our current model assumes a fade of rig productivity over time (applying the most recent rig counts). The three scenarios laid out below assume that the growth rate in production per rig fade to 0% by the dates given (from current growth rates). We can see how different fades will affect headline production.

The results imply that US crude production is likely to at least flatline unless rig count continues to decline or rig productivity growth rates lessen quickly.

Shell posts a blowout quarter in downstream

By Kim Fustier

Shell beat consensus expectations by ~30% in 1Q thanks to a blowout quarter in refining & marketing (where BP and Total also beat on Tuesday). Its downstream division posted the best quarterly earnings since the 'golden age of refining' in 2006-07. R&M profits were buoyed by strong global refining margins, cost savings initiatives and a healthy contribution from trading. Other majors with high exposure to downstream such as Exxon should also benefit from the current favourable refining environment, highlighting the value of integration.

Shell's Upstream performance was far less stellar, due to lower oil & gas prices and FX movements. Upstream Americas made its biggest quarterly loss in at least a decade.

Having previously guided to flat y/y capex of $35bn in 2015, Shell is now pointing to a $2bn reduction vs  last year's levels, reflecting delays to project sanctions. This does not come as a huge surprise as oilfield service costs continue to fall, giving majors opportunities to lower their project breakevens. 

BP's 1Q results show refining strength + tax one-offs

By Kim Fustier

BP's first-quarter results came in slightly better than expected; however this was largely thanks to one-off positive UK tax effects (as BP booked the benefit of the North Sea tax reduction in the quarter) rather than stronger underlying performance.

BP's upstream profits were hit by lower oil and gas prices as well as break fees for two deepwater rig contracts in the US Gulf of Mexico, which sent BP's US upstream business into a loss. Rig cancellation costs are likely to show up in other majors' results this quarter, as all majors rein in offshore drilling activity. 

On a positive note, BP appears successful at cutting costs as it took a number of simplification and efficiency measures early and aggressively, but this is not yet enough to offset the weaker macro. 

Results were also boosted by a buoyant downstream, once again demonstrating the value of integration. Majors with high downstream exposure such as Shell, Total or Exxon should benefit from the strong global refining environment, which BP expects to last into the second quarter.

A look at sentiment

By Will Forbes

Investors in E&Ps have suffered over the last few years as poor exploration success has exacerbated reducing returns (caused by increased capex and higher costs of capital). Sentiment in the sector has fallen, but is this measurable?

We think not, but there are some indicators that may be weak proxies.

Percentage discount of oil shares to estimated value (consensus analyst value)
We start by making the bold assumption that an approximation to the value of the company is the average target price as published by stock analysts.

Taking an index of London-based E&P companies over time and comparing the analyst valuations with actual share prices shows that the market-applied discount to E&Ps has changed little since January 2012. The apparent discount that the market applies is around 40%. 

Recent movements (such as Dec 2014-Feb 2014) are more likely the lag of analysts updating models than an actual move in sentiment (shares prices more quickly reflected the oil price falls than analysts).

Source: Bloomberg, Edison Investment Research

When examining individual companies, it is important to note the size effect. As companies become larger, more investors and analysts cover the company and we believe this is why we see the correlation between market cap and discount to consensus target price, as below. This view of an efficient market hypothesis would also explain why the range of uncertainty decreases with size as companies grow in market cap.

Source: Bloomberg, Edison Investment Research

It is also true that the smaller E&Ps are those with the greatest uncertainty in outcomes - this is perhaps the result of having fewer exploration targets, which does not mesh particularly well with the application of probabilistic CoS in general use.
Given this, one would assume it fair that this uncertainty would give rise to a greater discount to target prices, which tend to use consistent principles across the space.

Objections to this approach
Readers can very easily raise objections to this approach. Consensus target prices will be affected by the analyst's over-riding macro assumptions (assume $80/bbl or $100/bbl for long-term oil prices) and risk application (how is the level of exploration value to apply calculated). For example, in the boom years of mid 2000's, analysts and investors were more likely to include more exploration value, whereas it is our impression that inclusion of longer-dated exploration is less likely now.
Without a full database of analyst models/notes, it is not possible to separate out these effects. 

If this is true, it is up to the analysts to adapt their approaches to take this into account. We will expand on this theme in later blog posts. 

First Falklands well in two years looks positive

By Elaine Reynolds

An oil discovery at the 14/5b-5 well is a successful start to the four well North Falkland Basin campaign for Rockhopper (RKH 24%), Premier Oil (PMO 36%) and Falkland Oil & Gas (FOGL 40%). The well sits immediately to the south of Sea Lion in PL004b and was testing the extension of the F2 sands that represent the existing discovered resources at Sea Lion, as well as the the deeper untested F3 sands. All seven predicted reservoirs were encountered with oil in the primary target, Zebedee, and gas in the shallower Hector target. Good oil shows were recorded in the F3 targets, but the sands were not well developed at this location.

Of the targets encountered, pre-drill chances of success were highest at Zebedee (52%) and Hector (27%) so it is perhaps not a surprise that these are the two zones that have been most successful. However, even at these confidence levels there was a decent chance that the well could have failed, so we consider these results to be broadly positive.

The Zebedee fan encountered 25.3m of net oil pay with reservoir quality among the best found in the region to date. Pre drill resource estimates for all the targets ranged between 165mmbbls (PMO) and 281/282mmbbls (RKH/FOGL) with the Zebedee fan expected to contribute in the region of 50mmbbls. Of particular interest we note that FOGL believes that the Zebedee fan is in communication with Sea Lion based on pressure measurements. This would potentially impact FOGL's share of Sea Lion itself once unitisation discussions get underway at some point in the future.

The rig will now move some 40km to the south of Sea Lion to drill Isobel Deep. This well is higher risk than Zebedee and is only targeting the F3 sands. The F3 oil shows in Zebedee have demonstrated their potential to be hydrocarbon bearing, but better developed sands will need to be present here for the well to be successful.