2020 Exploration and Production Industry Outlook
Date June 12, 2020
With two nearly simultaneous shocks impacting the oil and gas market in March 2020, the upstream oil and gas industry has faced challenges greater than most during the first quarter of the year. Specifically, in addition to the spread of COVID-19 across the United States and the corresponding negative impact of business shutdowns on hydrocarbon demand, Saudi Arabia flooded the global market with crude at rock-bottom prices in an effort to punish Russia for its refusal to support Organization of the Petroleum Exporting Countries (OPEC) production cuts in early March 2020. While OPEC reached an agreement to reduce global output on April 12, 2020, bringing the Saudi Arabia-Russia conflict to an end for the moment, reduced hydrocarbon demand levels arising from the COVID-19 pandemic continue to impact the economy, albeit at a reduced level relative to prior months. In light of the current operating environment, outlined here are current expectations for the exploration and production (E&P) industry for the remainder of 2020 and beyond.
Decline in Rig Count
Within the hydrocarbon industry the number of oil and gas rigs actively drilling tends to represent a widely followed statistic that is an indicator of E&P company investment appetite and consumer confidence. As measured by the weekly rig count reported by energy technology company Baker Hughes, the upstream oil and gas industry responded rapidly to the supply and demand shocks experienced in March 2020. After remaining fairly stable between 780 and 800 rigs from January through mid-March 2020, the U.S. rig count began a rapid decrease from 792 for the week ended March 13 to 284 for the week ended June 5, a reduction of 64.1 percent. The largest area of rig count decline took place in the Permian Basin, which experienced a reduction of nearly two thirds from 418 for the week ended March 13, 2020, to 141 for the week ended June 5, 2020. It is important to note that, energy research company Rystad Energy forecasts that the second quarter of 2020 will represent the low point of fracking activity, with a recovery anticipated beginning in the third quarter of 2020.
Production and Price Expectations
With the rapid reduction in rig count, U.S. oil and gas production is expected to experience a similar decline in response to the first quarter’s supply-and-demand shocks. In addition to reduced production of newly drilled wells corresponding to a reduction in drilling activity, oil and gas production naturally experiences declines in connection with the monetization of existing wells. Specifically, shale wells typically decline 70 to 90 percent relative to their peak production within a three-year period, with the large majority of that production decrease taking place within the first 12 months. Consequently, the absence of current drilling activity can rapidly result in the loss of U.S. oil production. According to estimates developed by energy news website oilprice.com, the absence of drilling in U.S. shale basins would theoretically decline by more than one third to less than 5.0 million barrels per day by the end of 2020.
Considering an unfavorable price environment and reduced demand, current expectations for the E&P industry involve an acceleration in the number of bankruptcies while the lower price environment persists. Rystad Energy predicts there will be 73 bankruptcies during 2020 and an additional 170 in 2021 should West Texas Intermediate (WTI) remain constant at $30. To provide a basis for comparison, approximately 200 North American E&P companies filed for bankruptcy protection between 2015 and 2019. In order to avoid an accelerating rate of industry bankruptcies, Rystad Energy estimates underlying WTI prices will need to range between $40 and $45 per barrel.
From an appraised value perspective, most of the assets Gordon Brothers sees in this space are machinery and equipment. In the COVID-19 environment, Gordon Brothers expects that secondary market demand will be weak in the short term and weaker in the medium term due to an anticipated future reduction in natural gas production volume. Additionally, Gordon Brothers expects that secondary market demand for anything other than ongoing well servicing equipment such as lift equipment or other niche sectors will go to very low levels for as long as this price environment lasts. Concerning appraisal values from an inventory perspective, Gordon Brothers expects that there will be a material drop in tier I volumes and that tier II will be limited to low volumes due to market conditions and a weak structural market. Scrap is expected to be negatively impacted based on market weakness. Regarding oil and gas reserve values, Gordon Brothers anticipates values to decline modestly in the current environment, as current futures prices do not anticipate any major changes relative to current underlying hydrocarbon prices.
Gordon Brothers maintains a wide variety of experience with valuations in the upstream oil and gas industry, including the valuation of oil and gas reserves, contracts, machinery and equipment, and inventory.