Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

The secret to happiness is, of course, to lower one's expectations. It is also the secret to keeping oil prices lower for longer.

There is no shortage of bad news in the oil industry. You only have to look at sweeping job cuts announced in the past week by services giants Schlumberger and Halliburton or news of blackouts in a desperate Venezuela.

And yet hope isn't lost altogether, as two sets of company results announced late Monday and early Tuesday can attest.

Oil major BP just revealed a surprisingly good set of quarterly numbers. How good? So good that the share price jump was one of the best in response to any BP results in the past 10 years, Bloomberg data show.

Great Quarter Guys!
One-day share price reaction to BP's quarterly results
Source: Bloomberg

And yet, as fellow Gadfly Chris Bryant laid out here, BP's announcement wasn't exactly one for the ages.

Great Quarter Guys?
BP's replacement cost operating profit has shrunk significantly
Source: the company

BP clearly is stretching to deal with low oil prices. It took its investment budget for this year down another notch to reassure investors on the safety of the dividend -- good job, too, as debt continues to rise. (Across the Atlantic, rival Exxon Mobil just lost the triple-A credit rating it has held for decades.)

More importantly, BP now says it will be able to fund its capital expenditure and dividends with operating cash flow next year even if oil averages just $50 to $55 a barrel. That breakeven price has dropped from the $60 level the oil major set just six months ago.

A similar message came from the opposite end of the scale, in the form of Pioneer Natural Resources' first-quarter numbers and guidance. Reporting an outright loss, the U.S. exploration and production firm was nonetheless rewarded with a 6 percent jump in its stock price, way ahead of its peers. With that, the stock is almost back to where it closed on May 1, 2015, just before Greenlight Capital's David Einhorn announced his case against the company he dubbed "The Mother-Fracker".

Frack Back
Pioneer's stock is almost back to where it was before Einhorn laid out his case against it
Source: Bloomberg

Einhorn's case, reasonably enough, was that Pioneer was just one of many E&P companies that burn cash for growth but would struggle to grow amid low oil prices. As you can see, Pioneer's stock certainly fell. And it has certainly continued to burn cash. Meanwhile, the oil price, even with the recent rally, has dropped by a quarter since then.

But Pioneer has kept growing. Production was up 14 percent in the first quarter from a year earlier, and the company expects 12 percent growth for 2016 overall.

Pioneer, like BP, is doing more with less, enabled by capital markets that have reset their expectations in accordance with lower oil prices. In particular, Pioneer has amped up its fracking, pumping more sand and fluid into longer wells and blasting the rocks below ground at ever smaller intervals of distance. This coaxes more output from each well, reducing Pioneer's unit costs.

Drilling Down
Pioneer's drilling and completion costs in northern Wolfcamp-B area wells
Source: the company

Pioneer, like any E&P company in the business of charming investors, highlights results from its best wells. And even in the Wolfcamp wells detailed in this chart, the pace of cost declines has clearly slowed in the past couple of quarters.

But Pioneer points out that part of this slowdown is due to old terms agreed with contractors in better times. When these roll off, those costs should fall further (no wonder the likes of Halliburton are still cutting headcount). 

Pioneer says it should be able to start adding rigs back when oil is at $50 a barrel and believes that if oil climbs back to $60 over the next year or so, it should be self-funding in terms of covering capital expenditure.

For oil bulls, Pioneer's guidance toward $60 a barrel and expectations that U.S. output overall will decline further in the second half of this year are comforting. Oil trades at around $44 now.

Yet consider that only a year ago, $60 oil in 2017 would have been a bear case.

Fifty is the New Sixty
Average futures prices for WTI crude oil
Source: Bloomberg

While pressure continues to build on the oil industry, as BP's rising debt and Pioneer's losses demonstrate, costs continue to fall in response. Falling investment and headcount cuts will weigh on future supply, supporting further rallies at some point.

Equally, though, these lower breakevens imply that, absent a genuine supply shock, those rallies will be capped. The reality of the shale boom is that its fortunes are tied more closely to technology and operating improvements than the luck of striking a conventional reservoir. This is a fundamental change because it is an ongoing source of deflation that will weigh on price cycles over the long term. More E&P companies may go bankrupt over the coming months and years. But their assets will likely end up in the hands of a rival able to exploit them at a lower cost.

The real constraint is having the capital. And despite everything, the E&P industry continues to attract it. Not everyone is able to participate, but the likes of Pioneer certainly can. It kicked off 2016 with a $1.6 billion equity offering when oil was trading closer to $35. Since then, another $8.6 billion of new U.S. E&P equity has been sold, meaning the sector is so far outpacing even last year's bumper issuance.

What's more, investors who bought are doing nicely.

Sales Pitch
Average performance to date of new stock sold by U.S. E&P companies, as per quarter of issuance
Source: Bloomberg

Notice, too, that investors have been buying new E&P equity despite the losses made on all the new shares issued throughout 2014 and the first half of 2015. It turns out that, when it comes to oil, the real secret to happiness is a short memory.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net