Image Source: Apache Corporation.
With the world's oversupply glut entering its second year, oil companies have come to the realization that investing to grow oil production isn't the best use of capital right now. In fact, many are deciding that it's not worth it to invest what it would take to keep production flat, instead choosing to invest within projected cash flow and allowing production to slowly decline. It's a path that Apache (APA 5.70%) has recently chosen to take after announcing a 2016 capex plan that significantly cuts spending and production.
What goes up ...
In 2015 Apache, like most other oil companies, continued to invest to grow oil and gas production. In doing so it pushed its full-year production up to an asset sale adjusted rate of 486,000 barrels of oil equivalent per day, or BOE/d. That represented production growth of 3% out of its North American onshore unit and 13% from its international and offshore segment.
That growth didn't come cheap, with Apache spending $3.6 billion in capex last year, which was a lot more than the $2.8 billion in operating cash flow it pulled in. That difference, however, was covered by asset sales, with Apache unloading $6 billion in assets during the year, which also significantly improved its balance sheet.
A continued focus on growing production was the same path many of its peers took with Marathon Oil (MRO +0.00%), for example, spending $3 billion to grow its production by 8%, including 21% from its U.S. resource plays. While that was 50% less than Marathon Oil spent in 2014, it was nearly double the company's $1.6 billion in cash flow from operating activities. Meanwhile, Devon Energy (DVN 3.39%) grew its overall production by 7%, while oil production out of its core assets surged 26%. However, thanks to strong oil hedges, Devon Energy's capex of $5.3 billion roughly matched cash flow of $5.4 billion.
Image Source: Marathon Oil.
... Now comes down
With oil prices even lower in 2016, oil company cash flows are projected to shrink further in the year ahead, leaving them with even less cash to invest. That's also leaving them with a tough choice to make. They could push the limits and invest to keep production at least flat, or go the conservative route and stay within projected cash flow, even if production falls.
With the oil downturn now in its second year, that more conservative route is the one most oil companies are taking. In fact, Apache only plans to spend between $1.4 billion to $1.8 billion in capital this year, which at the mind-point is 60% less than last year and 80% less than 2014. That's expected to balance capex with cash flow at a low-to-mid $30 oil price. Further, that budget is backstopped by the fact that Apache has $1.5 billion in cash sitting in the bank.
Likewise, Marathon Oil is slashing its 2016 budget to $1.4 billion, or 50% less than what it spent last year. Though, it's more living within its means than within cash flow, with the company planning to sell at least $500 million in non-core assets to help balance things out. Finally, Devon Energy is cutting a stunning 75% from its capex budget bringing it down to a range of $900 million to $1.1 billion and leveling it with cash flow, which will fall significantly after its strong oil hedges dried up at the end of last year.
With these spending cuts, all three companies will see their production fall over last year. Apache expects its to slump 7% to 11% over last year, Marathon Oil projecting its production to fall 6% to 8% after adjusting for asset sales, while Devon Energy sees its production slumping by 6% at the mid-point.
Clearly, these companies have hit the point where they just can't justify spending what it would take to drill enough wells to replace the production from declining and depleting legacy wells. Further, they are becoming increasingly focused on living within projected cash flows at the current oil price and not assuming an oil price rebound, nor using their balance sheets or a barrage of asset sales to cover big cash flow shortfalls. In other words, survival is trumping not just growth, but even the thought of trying to keep production at status quo right now.
Investor takeaway
At $30 a barrel, oil companies have finally hit the point where they are no longer comfortable investing beyond their means, which will cause production to decline. That's going to have a big impact on oil supplies later this year, which is actually what the oil market really needs to see right now. It could finally lead to a rebalancing of the oil market, and a return of a more favorable oil price.
