This week, Barclays (NYSE:BCS) came out with a report that forecasted 2017 to be much brighter for U.S. oil and gas.
On this episode of Industry Focus: Energy, Motley Fool analysts Sean O'Reilly and Taylor Muckerman go over the most important points from the report -- how much spending and production is projected to increase by, which micro-sectors will see the most change, why the E.U. is seeing a drilling decline amid this growth, and more.
Also, the hosts talk about a report from the U.S. Department of Energy, which happily reports that U.S. oil declines are finally over for the first time in several years. Listen in to find out how nervous companies are going to be about ramping up production in light of the last few years, and a few companies that investors might want to look into that could benefit from this upside.
A full transcript follows the video.
This podcast was recorded on Jan. 12, 2017.
Sean O'Reilly: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, January 12th, 2017, so we're talking about energy, materials, and industrials. I'm your host, Sean O'Reilly, and I'm joined in studio by the incomparable, the devilishly handsome, the spectacularly awesome Taylor Muckerman. What's up, man?
Taylor Muckerman: And that's our show, ladies and gentlemen!
O'Reilly: Yeah, we're going to go to a bar now. How's it going, man?
Muckerman: It's good, what about you?
O'Reilly: I cannot begin to tell you how much I'm loving the 60 degree weather today.
Muckerman: Yeah, short sleeves right here.
O'Reilly: It's going to go away tomorrow, but it's a nice break. Breaks are important.
Muckerman: Fleeting to sleeting.
O'Reilly: (laughs) What did you just say?
Muckerman: Fleeting to sleet --
O'Reilly: No, I heard you, I just can't believe I have lived 30 years and haven't heard that before.
Muckerman: I've never heard it before either.
O'Reilly: You just made it up on the spot?
Muckerman: Yeah. That's what this podcast is all about.
O'Reilly: I'm going to walk down the street and patent that at the trademark office.
Muckerman: Fleeting to sleeting? OK.
O'Reilly: (laughs) Get the domain name.
Muckerman:Google it, somebody might have said it before.
O'Reilly: You think? You don't think you heard it in the cultural nexus?
Muckerman: No, I never heard it before, it's just off-the-cuff.
O'Reilly: Lies. You were watching something on Netflix last night and you just heard it.
Muckerman: No Netflix.
O'Reilly: It's on Always Sunny, isn't it?
Muckerman:If it's on anything that I grabbed it from, that's a good guess.
O'Reilly: That would be my bet. How did I know you watch that?
Muckerman: It's Always Sunny in Philadelphia is the show.
O'Reilly: Oh, yeah, I apologize, folks. Another gentleman that happens to be one of our other podcast host that loves that show is the Tech show's Dylan Lewis, if anybody wants to email him about their shared love of Always Sunny in Philadelphia.
Muckerman: What is it, email@example.com? (laughs)
O'Reilly: Dylan, I'm sorry. Yeah, those Always Sunny fans ... our producer Austin is looking at us like, "I'm going to email Dylan right now." (laughs) Taylor, we've been talking about this theme a little bit -- because we do have to talk about serious things, in addition to It's Always Sunny in Philadelphia.
Muckerman: Yeah. You have to open it with a laugh.
O'Reilly: You sent me a great article that covered a report put out by Barclays, the investment bank. U.S. oil and gas drilling to lead to 2017 global growth. Not surprising because OPEC literally told everybody, "Hi, we want higher oil prices." We're not at $27 a barrel anymore like it touched down at last February, we're at the low 50s. I was interested to see what they were talking about in the report. They talked about how U.S. production led by the oil majors, in terms of capital spending, likely to go up just under 60%.
Muckerman: Hi Ho silver.
O'Reilly: Wow. Keep in mind, also, that they were at post WWII lows of all time last year, so this is not crazy. Spending will increase 700% worldwide. This was the other cool statistic -- spending dropped by 38% last year by U.S. shale drillers.
Muckerman: Yeah, that's U.S. shale. Globally, it dropped 23% last year, following a 25% drop in 2015. So, you lopped off a quarter of spending in 2015, and then you lopped off another quarter on top of that in 2016. It's a complete reversal.
O'Reilly: The headline number that I started off with sounds big, but really, if you lose 50% of your money, you have to double it to get it back.
Muckerman: Yeah. They're not doubling it. They're not getting back to where they were in 2013-2014. But they're trying.
O'Reilly: Yeah. International drilling only increased 2%. National oil companies, like those in Russia and the Middle East, plan to spend 9% more, and this was offset by 7% decline in European companies.
Muckerman: That's backwards, because Russia and the Middle East are supposed to be cutting production, but they're going to spend more.
O'Reilly: This is suspicious, what's going on here?
Muckerman: Makes me stroke my beard, thinking about that.
O'Reilly: When it says "European," is this basically Total and BP?
Muckerman: When you think about Europe and the cost curve, a lot of European production comes offshore in the North Sea.
O'Reilly: That's just naturally declining.
Muckerman: Well, that, and it's higher up on the cost curve. And then, even shallow water in the European Union, you're looking at around $71 break even. So it's really high up there on the cost curve, it's out there past Brazilian deep water, it's out there past Canadian oil sands. The only thing I think that might be more expensive is West African offshore production. That's probably why the E.U. is seeing a decline, because A, the North Sea is difficult, and you're having to push out the risk curve --
O'Reilly: But the weather is so nice out there.
Muckerman: -- because they've been drilling there for so long that the low-hanging fruit has pretty much all been pumped. And then, like I said, the price curve you see, it's just more expensive, and it's not profitable right now.
O'Reilly: Can we define that for the layman? What is the cost curve, the price curve, that you're referring to?
Muckerman: It's just the average break-even cost per barrel to produce in a certain region.
O'Reilly: And, obviously, that varies on planet Earth.
Muckerman: Yeah, it does. You look at, I think the cheapest in the United States might be the Wolfcamp in the Permian, which is around $39 a barrel, so quite profitable now.
O'Reilly: Does that include buying the land, or the lease?
Muckerman: I think the break even is just going to be the drilling activity to pump it out.
O'Reilly: OK. So, buying the land, you would need $50-60 to make it economical.
Muckerman: Yeah, I don't know the exact math, but once you own it, they're making money on the drilling alone right now. Then, you have the Eagle Ford break even at around $48 a barrel. Onshore OPEC around $40 a barrel. Then, Canadian oil sands, $54. So you have from $39-71 between the Permian and European shallow water.
O'Reilly: Now, you said OPEC, really quick, there's tons of variation there, because that's a couple dozen countries.
Muckerman: Yes. That's the average of the onshore OPEC.
O'Reilly: Right. And as I understand it, Qatar and Saudi Arabia are at the very bottom, like, they stick a straw in the sand and they have oil at $9 a barrel.
Muckerman: Yeah. They're the conventional style. There's not that much shale drilling going on. They have these big basins that they can just tap into, as we used to drill, back in the 70s and 80s.
O'Reilly: So, if my college econ professor were here, he would say that long-term, commodities need to be priced at their marginal cost of production for that last bit of supply that you need to meet demand. There's some debate, because a lot of these countries self-report and all that fun stuff, but the world right now needs about 96 million barrels. And as I understand it, and even the report bore this out, they noted in the Barclays report that only offshore drilling will continue to suffer. My understanding is that that couple of million barrels per day that the planet needs comes from offshore.
O'Reilly: And you're telling me that they are still cutting because they need higher prices. Correct me if I'm wrong, but that has implications.
Muckerman: Yeah. You've seen some interest in Mexico offshore, they had a lease auction a couple months ago, they had some interests from the majors for that. But Brazilian deepwater, not nearly as high as the North Sea or any European drilling or African drilling on the cost curve. But, you still see some question marks there because of the government involvement with Petrobras and all the requirements that they make, so people are still a little wary of getting involved with drilling in Brazil. But yeah, eventually you're looking about, you could probably say in the next 5-10 years, you're going to see spending ramp up there. But that Barclays report suggests that offshore spending is going to drop by 20% again this year.
O'Reilly: Wow. It seems to me like you're going to get a full recovery in shale way before offshore.
Muckerman: It's already started. You saw this fourth quarter -- which segues into our next topic, I think -- the first quarter of production growth in the U.S. since early 2015.
O'Reilly: Who'd have thunk?
Muckerman: So, it is turned around already, up from 8.9 million barrels per day last year, which was down from 2015 slightly, and definitely down from 2014, but we're expecting an uptick here this year in 2017.
O'Reilly: Got it, cool. So, Mr. Muckerman, you mentioned our next topic, nice segue there, U.S. Department of Energy says that U.S. oil production declines are finally over. What has it been, two years?
Muckerman: Yeah. Early 2015, late 2014 is when people started to get tense.
O'Reilly: That's when I started doing this podcast. Maybe I was the cause. (laughs)
Muckerman: (laughs) You're the jinx? Yeah, 2015, you saw production slide. 2016 saw production slide. But apparently we're on the up.
O'Reilly: I have two questions for you. No. 1, how nervous is everybody going to be? How conservative are they going to be in ramping up production?
Muckerman: I don't know. You saw, like you mentioned, in the fourth quarter, we saw an uptick in production. You're still going to see the folks that can produce the cheapest, have the best odds of "winnning." Companies have been buying up land, they've been issuing stock to do so, they've been spending on their balance sheet to do so. And that's always been, at least in the last few months, in these basins like we talked about, the Eagle Ford and the Bakken, and maybe a little bit in the Utica, which is right there in Ohio, West Virginia, Western Pennsylvania region. So, they're really trying to find acreage that can produce at the $39 a barrel that we talked about in the Wolfcamp, or the $48 barrel break even in the Eagle Ford. So, I would imagine some trepidation in terms of people getting out there and tentatively starting to drill again. But, we've talked about it before, a lot of unfracked wells that folks just have that last stage to do, which is basically fracturing the wells. Horizontal drilling has already been done. So fracking and pumping is all that's left for a lot of those wells.
O'Reilly: I guess what I mean is, I can't remember where the land rig count topped out at. It was 1,300 or 1,400.
Muckerman: It was a lot.
O'Reilly: It was up there. We bottomed out at 300 or 500 or something, it was very low.
Muckerman: It's been a few months of rising rig counts, and that's mostly been in the Permian. Texas has been holding the mantle of increased drilling.
O'Reilly: I just have to assume it's going to be a while, or we're going to need way higher oil prices, for the rig count to get back to that level.
Muckerman: Yeah. Who knows if we ever see it again?
O'Reilly: Because they've gotten even more efficient. You know what I mean?
Muckerman: Yeah. Pad drilling where you can use the same rig on multiple wells within a smaller footprint, because you're basically just putting these rigs on a track, rather than having to disassemble them every time you want to drill a well. So yeah, they're more efficient, you can use a rig more than once over the course of a few weeks, rather than a couple times a month. Yeah, Halliburton (NYSE:HAL), Schlumberger (NYSE:SLB), Baker Hughes (NYSE:BHI) are making it work in terms of not needing as high of a rig count, and I think that will benefit the entire industry.
O'Reilly: Bringing it back around, because this is an investing podcast, we've hit on two themes -- one, the U.S. production declines are over.
Muckerman: Supposedly over.
O'Reilly: Supposedly over, anecdotally, we think so. So, that obviously lends itself to increased equipment usage. So, Baker Hughes and Halliburton, that's good for them. Is there any other sure bets in there in terms of assuming U.S. oil is back?
Muckerman: In terms of the big three services companies, Baker Hughes and Halliburton, Halliburton being number one, I would say, if you do see that divergence between a massive uptick in U.S. drilling spend, versus a minor 2% ex-U.S. global spend -- because Schlumberger gets the majority its revenues internationally, whereas Halliburton and Baker Hughes get the majority of their revenues domestically -- those would be the two I would focus on if you're looking at a services company. We mentioned the two low-cost basins in the United States, the Eagle Ford and the Permian. Just, without getting into these companies specifically, these are just the top producers in those two basins. If you look at the Permian, you're looking at Occidental Petroleum, Chevron, Apache, Exxon, and Concho Resources. If you're looking at the Eagle Ford, you're looking at EOG, which is not even close to the second place, which is so far down the list in terms of assets --
O'Reilly: EOG is the largest independent producer in the U.S.
Muckerman: Yeah. So, EOG is number one. ConocoPhillips is two. BHP Billiton, Chesapeake, and Marathon Oil. So, you have 10 companies there you can go look at between those two basins. But then, also, we're looking at an uptick in natural gas production, because you see exports coming online in 2016 with a couple trains down in Sabine Pass for Cheniere Energy. They also have a couple more trains that should come online this year, a train being one single means of export. All these trains are similar in terms of what they export, but they bring them online individually. And then, you have Dominion focusing on its Cove Point facility in Maryland. That should come online this year as well. So, not only are we needing more natural gas domestically for energy production, but we're also now able to export it, and that's finally coming online.
O'Reilly: A lot of good leads there.
Muckerman: A lot of good leads.
O'Reilly: And, basically, the theme is, we're not endorsing any of these names, but those are the two lowest-cost areas, in terms of U.S. onshore oil production, and both of the companies that are the biggest players.
Muckerman: Correct. If you want to look at natural gas companies for the export, you have Cheniere and Dominion. Then, there's plenty of producers out there you can take a look at, Southwestern or Range Resources, both of those are pretty heavily tied to natural gas, Chesapeake as well, it has the nice assets in the Eagle Ford but then it's also heavily embedded in the Utica, which is predominantly natural gas and natural gas liquids.
O'Reilly: They're also heavily indebted on their balance sheet. (laughs)
Muckerman: (groans) Energy jokes, financial jokes!
O'Reilly: I had to, I'm sorry.
Muckerman: It's fine. You can't let them slide, they've had a rough 5-10 years. Who knows? It seems like they're getting their act together.
O'Reilly: Yeah. All right. Thanks for your thoughts, sir.
Muckerman: Yeah. Appreciate it.
O'Reilly: Have a good one, enjoy the weather.
Muckerman: Yeah. Well, I'm inside.
O'Reilly: Well, go out for lunch. That is it for us, folks. Be sure to tune in tomorrow for the technology show with Dylan Lewis. If you're a loyal listener and have questions or comments, we would love to hear from you, just email us at firstname.lastname@example.org. As always, people on the program may have interests in the stocks that they talk about, and The Motley Fool have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Taylor Muckerman, I am Sean O'Reilly, thanks for listening and Fool on!