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.

Things are looking up in Shalelandia these days. Oil prices, despite the most recent drop, have stayed close to $50 a barrel. Rig-counts and production are rising. Even Saudi Arabia is looking discombobulated.

Lest we forget, though, the chief reason things are looking up is because E&P companies fell way down.

Back in October, Gadfly surveyed the financial performance of 11 of the biggest oil and gas producers focused on North America. Now that they have all filed their 10-Ks for 2016, we can see how they fared in the very depths of the oil crash.

The first thing to note is that the sector's almost clichéd resilience cracked in one respect: Output broke a pattern of double-digit growth and actually declined overall. Only four of the 11 companies managed to raise their production: Concho Resources Inc., EQT Corp., Pioneer Natural Resources Co. and Range Resources Corp.

Time Out
The output of a group of big U.S. E&P companies fell by 1.8 percent in 2016, having grown by 11 percent annually on average in the prior six years
Source: The companies
Note: Aggregate data for 11 large U.S. E&P companies. Natural gas converted to oil equivalency at 6,000 cubic feet per barrel.

That slight dip in crude oil production hurt the most. The E&P sector has been shifting toward higher-value oil over natural gas, where prices crashed and have stayed low. Crude oil and other liquids are now almost 44 percent of the mix, up from 23 percent in 2009:

Liquidity
E&P companies have chased higher-margin oil production to compensate for the crash in natural gas prices
Source: The companies
Note: Shares of major products in annual production. Data are for 11 large U.S. E&P companies.

This shift in the production mix has been crucial to offsetting some of the pressure on realized prices. While Nymex crude oil might be trading at around $50 a barrel, E&P companies selling a mix of products in different regional markets realize very different actual prices per barrel of oil equivalent. Selling more oil helps, but it couldn't fully offset the carnage of the past two years:

Realization Dawns
Average realized prices peaked at about $42.50 before the crash. In 2016, they fell below $20
Source: The companies, Bloomberg Gadfly analysis
Note: Average realized price per barrel of oil equivalent for 11 large U.S. E&P companies. Excludes the effect of hedges.

Oil-weighted companies such as Pioneer enjoyed the relative sanctuary of realized prices in the upper $20s, while at Southwestern Energy Co., producing 90 percent natural gas, they actually fell below $10 (before hedging effects).

As you might imagine, this didn't do wonders for margins per barrel. The E&P companies report these in different ways. Gadfly calculates an adjusted production cost per barrel of oil equivalent, including not just costs directly involved in producing oil and gas, but also the non-income taxes, general and administrative and interest costs reported in the companies' filings. It's a more conservative measure that recognizes the corporate overhead each barrel must support; after all, you buy shares in a company, not a set of wells.

Chop Chop
Production costs are back down to 2010 levels, but higher leverage has pushed up interest charges
Source: The companies, Bloomberg Gadfly analysis
Note: Aggregate production and overhead costs per barrel of oil equivalent produced for 11 large U.S. E&P companies.

Comparing these to realized prices, margins per barrel plummeted by almost 75 percent between 2014 and 2016:

The Big Squeeze
Despite cost cutting and productivity gains, margins fell below $8 per barrel of oil equivalent in 2016
Source: The companies, Bloomberg Gadfly analysis
Note: Aggregate all-in margin per barrel of oil equivalent for 11 large U.S. E&P companies. Excludes hedging effects.

None of the 11 companies actually tipped into negative margins, although, on Gadfly's methodology, Southwestern's and EQT's fell to a buck or less.

That the group's output fell by less than 2 percent in 2016 in the face of such a collapse in realized revenue and profits is a testament to its collective -- yes -- resilience.

But the foundation of that resilience has been access to U.S. capital markets. While net debt in absolute terms actually fell between 2014 and 2016, aggregate leverage for the group jumped from 1.3 times trailing Ebitda in 2014 to 10.4 times in 2016, according to figures compiled by Bloomberg. Only the remarkable faith of, in particular, equity markets in a brighter future has prevented even more of a shake-out in the industry.

Indeed, it is this dynamic that has so perturbed Saudi Arabia in the past couple of weeks.

On the one hand, it would like to finish the job of squeezing higher-cost rivals out of the oil market; our analysis shows it was clearly making progress on that front in 2016. On the other, though, an IPO of Saudi Aramco is supposedly not far off. So its owner, the Saudi Arabian government, is now compelled to keep the equity market feeling good about oil's future.

The unwelcome side effect? Suffering rivals in the shale patch can free-ride on such optimism to repair themselves and resume growing.

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

  1. They are: Chesapeake Energy Corp., Cimarex Energy Co., Concho Resources Inc., Continental Resources Inc., Devon Energy Corp., Energen Corp., EOG Resources Inc., EQT Corp., Pioneer Natural Resources Co., Range Resources Corp. and Southwestern Energy Co.

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

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