Natural gas producer Magnum Hunter Resources Corp (NYSE: MHR) recently held a conference call to update its investors on the company's future plans. The company surprisingly said that it won't spend any more money to drill new wells until oil-field service costs come down. It's one of the boldest moves yet by an energy company as Magnum Hunter looks to take advantage of the weakness in oil prices to boost its own returns.
Slowly rolling back prices
Most energy companies are cutting back capital spending as a result of lower oil prices. Smaller, shale-focused drillers in particular are cutting spending by about 50% on average. However, these cuts are mainly due to a corresponding drop in cash flow. Said another way, oil and gas companies continue to drill up to their spending limit in order to make up on volume what they're now missing on margin.
That said, margins could be boosted in the near future as these capital spending cuts force oil-field service companies to reduce their prices in order to maintain market share. This is why oil-field service giant Halliburton Company (NYSE:HAL), for example, has said it expects to endure pain in the year ahead as its business is affected by reduced activity and falling service prices.
In fact, Halliburton's CEO Dave Lesar was pretty up-front with investors on the company's fourth-quarter conference call as he thought that the company's margins would be squeezed over the next year as it would need to reduce its prices. Lesar even said that, "Price discount discussions with customers did begin in the fourth quarter and have accelerated over the past several weeks. And price reductions are now occurring across all product lines."
Waiting for the Black Friday sale
However, oil-field prices have yet to come down enough for Magnum Hunter Resources as it sees deeper discounts on the horizon. Speaking on the conference call last week, CEO Gary Evans likened the current market environment to retail sales where shoppers wait for the sale, like Black Friday for example, before they start spending money. Evans said that,
If Neiman Marcus is getting ready to have a sale, 50% off sale, why are you buying the jewelry or the clothing today, when the sale is going to be coming here in a few weeks? My motto is, we know there is going to be huge discounts on oil field services.
He went on to say his company is simply going to wait until oil-field services go on sale before it invests in new wells. He specifically noted that his company is "shooting for 40% discounts," when it came to service costs and that "It will take time. Oil-field services have got to feel the pain." But that he was, "not going to spend $2 today for something I could spend $1 on six months from now."
That said, Magnum Hunter Resources is in a bit of a different position than its peers. The company has built in growth to fuel its results over the next year as Evans noted that the company already drilled a number of wells that are scheduled to come on-line over the course of 2015. Further, it had to shut-in the production of some of its legacy wells last year to drill these new wells on the same well pad, and because of this production should actually jump 100% over 2014 levels without spending a dime on another new well. So, it really doesn't need to spend money to grow this year, however, it will take advantage of lower service prices when they arrive.
Falling oil prices should lead to falling oil-field service costs. Because of this Magnum Hunter knows that a big sale in service costs is coming, so, it's not going to spend any more money on new services until it can buy them at a huge discount. This trend of falling service costs really could be one of the big drivers for energy companies in the second half of 2015, which could lead to much better cash flows and returns than investors currently expect to see this year.