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US upstream companies feel the strain

Economic uncertainty forces E&Ps to significantly revise down their capital budgets

The Covid-19 outbreak seemed little more than another temporary shock to long-term rangebound energy markets barely a month ago. China appeared to have contained a largely localised phenomenon, and observers were estimating how long it would take Asian demand to recover. Oil producers stuck firmly to their 2020 production guidance. 

But events have changed radically. Europe is now the epicentre of a global emergency that could last months and test the healthcare capabilities of governments throughout the world.

The associated collapse in global energy demand—and uncertainty how and when supply will respond in the wake of Opec+ disarray—have shocked commodity markets. “The weak global economy was not ready for Covid-19, which is why we are seeing escalated panic in the markets,” says Louise Dickson, an analyst at consultancy Rystad Energy. “And unlike structural economic collapses, we do not know when the corona effect will ease up—markets could be wrestling with the virus well into 2021 in a worst-case scenario.”

Exploration cutbacks

In response, many US E&P companies have drastically downgraded their capex budgets and production forecasts. “Literally every day there are at least a couple of companies announcing capex reductions,” says Pavel Molchanov, director and equity research analyst at US bank Raymond James. “In many cases, quite sharply, by 30pc or even more.”

US producers with international exposure have notably been forced to scale back. US independent Hess confirmed it will reduce its capex by 26.7pc this year, to $2.2bn. To safeguard its finances, Hess will shift from a six-rig programme to just one rig in the Bakken basin—reducing production guidance by c.5,000bl/d to 325,000-330,000bl/d.

“What we are seeing here is essentially the atomic bomb equivalent in the oil markets” Dickson, Rystad

Further exploratory drilling offshore Guyana will be suspended despite joint partner ExxonMobil identifying 50 potential drilling prospects. Output growth from the Liza project offshore Guyana, which started up early last year, remains the company’s core priority.

The global portfolio of Texas-based Kosmos Energy has also been affected. The company said it will suspend dividends until market conditions improve. Kosmos added that it aims to reduce its capex budget by 30pc and maintain production at the same level as last year. 

In February, the company achieved a gas sales agreement for phase 1 of its Tortue project offshore Equatorial Guinea. Further capital spending on the project will be delayed until at least next year. The remaining capex needed for the project is $600mn. Kosmos expects to raise the necessary funds through a partial farm-down or the divestment of its Bir Allah field, offshore Mauritania, or Yakaar/Teranga assets, offshore Senegal.

Plans to drill three exploratory wells in the Gulf of Mexico are unlikely to proceed after Kosmos pledged to cancel exploration in the region. Similarly, the Jaca prospect scheduled to be drilled offshore Sao Tome and Principe in late 2020 is in doubt.   

Trouble brewing

Domestic US E&P companies will also suffer financial hardship this year if the oil price continues to plummet. Rystad says a $40/bl scenario this year would reduce North American shale investments by 25pc.

Many Permian producers—including Marathon Oil, Apache and Concho Resources—have already dialled back their spending. Notably, Occidental Petroleum is facing financial pressure because of its mounting debt. The company considerably added to its Texas acreage last year when it acquired Anadarko Petroleum for $55bn. But the purchase quadrupled its debt obligations, and even before the price crash it was forced to slash production guidance and expenses to finance its dividend payout.

$1.7bn – Occidental capex cut

Occidental’s share price has fallen by over 70pc since January, causing justifiable alarm to investors. In response to the volatility, the company has revised its capex down by $1.7bn and reduced its quarterly dividend by a hefty 86pc—to its lowest level in over 20 years.

Many companies are relying on hedging to offset the oil price volatility. Occidental has hedged 300,000bl/d. Similarly, Hess says it has hedged 80pc of its portfolio this year. But the hedging scheme still leaves Occidental with a $40/bl WTI breakeven in 2020. If crude continues to slump below the $40/bl threshold then many companies will feel serious financial strain, and cutbacks are likely. “What we are seeing here is essentially the atomic bomb equivalent in the oil markets,” says Dickson.

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