With many of you off to New Orleans this week and 1Q earnings season around the corner, our slide deck provides a fresh list of questions for management across our coverage universe. The topics hit on key industry issues and concerns, including spending thoughts, decline rates, parent-child well implications, development style, scale, M&A, balance sheet leverage, hedging, and Colorado risk.
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We spent three days and logged 240 miles driving around Houston visiting 10 E&Ps this week. Not surprisingly, with WTI/Brent near $60/$70, the tone was upbeat, as FCF outlooks are looking better vs. initial forecasts and drilling efficiencies are still coming through, but we also addressed concerns over Colorado risk and the parent-child issue that could present inventory challenges. Overall, we left on a positive note and importantly, see budgets being held in check despite the improved commodity outlook. Company by company notes inside.
Nice bounce back for E&Ps this week with our index +6.8% vs. the +2.9% move for the S&P500 and wait for it....the +4.5% WTI move. With the 12-month strips at $59/$65 WTI/Brent, the E&Ps are now moving well into positive FCF territory and we believe that was the key driver of outperformance this week. Of course, that’s going to start up the “when are you going to increase activity” questions, and after a trip down to Houston this week to meet with 10 producers, we’ll have a better idea how the sector is reacting to crude oil’s strength. A few producers have previously outlined $50/bbl vs. $60/bbl spending plans, so we’ll see if there is already motion on this. We’ll share our takeaways next Friday at 10am on the weekly Wolfe Energy webcast.
Why Now? We continue to believe that the E&P sector is ripe for consolidation up and down the market cap spectrum. However, there must be driving forces to push the sector down this path, whether it’s poor returns or changing sector dynamics, which is what we address here – why will E&P consolidation happen now?
Post 4Q18 earnings, we again compare our bottoms up vs. top down views of Appalachia natural gas supply growth through 2020. Key from this update is a meaningful downward volume response from the Northeast producers, as they push to improve free cash flow outlooks against a declining forward curve. Our new bottoms up 2019 gross Appalachia forecast, which takes the outlooks from our seven covered natural gas producers and CNX, now shows 1.5Bcfpd y-o-y growth, down 0.5Bcfpd from our prior forecast, and falling below the 1.7Bcfpd estimated in our top-down Supply model. Along with some late cold Winter weather, we believe the lower volume outlook has been supportive for the 2019 curve remaining near $3/mmbtu. However, we continue to see an oversupplied market in 2020 with another 1.5Bcfpd of bottoms up growth coming vs. our top down model suggesting the need for only 0.9Bcfpd. In our view, until this gap narrows, we see the forward curve having downward pressure. See the details on page 3.
Never a dull moment in the Energy sector. Just when you thought it was going to be a quiet Friday, Norway shakes up the E&P sector and WTI is down 2.5% before we get into the office. Oil was able to bounce back some to finish down 1% on the day, but our E&P Index didn’t get the same memo, ending down 4% and bringing the weekly tallies to: WTI +0.5%, E&P’s -8.2%. This wasn’t just a one week divergence either, as WTI increased 6% in February while our E&P Index was -0.6%. The trend feels very reminiscent of the 2H17-1H18 period when the equities couldn’t catch up to crude oil’s move to $70/bbl.
With 4Q18 finished, we updated and reviewed the natural gas producers’ cash margins, looking for key changes and outlooks that may be improving or deteriorating. Overall, each producer saw an uptick in 2018 y-o-y with an average uplift of 26% driven by improved liquids pricing and new regional pipeline takeaway & processing capacity coming online to support higher realized natural gas pricing. EQT saw the greatest increase on a percent basis (+41%) while CHK saw the greatest increase on a $/mcfe basis ($0.68/mcfe). However, looking into 2019/20, we see diverging outlooks driven by changing commodity mix, transport costs, and lower natural gas prices with overall margins declining 12% in 2019 and another 7% in 2020.
Two things from us this weekend. First is the underperformance of the SMID caps vs. the Large Caps during the month long 4Q18 earnings season and second, we put four scenarios together for CDEV to see what the outlook through 2022 may look like following the strategy shift this week.
Earlier this week, Royal Dutch Shell (RDS/A - OP, covered by Sam Margolin) released its 2019 and long-term outlook for the global LNG market, reiterating its bullish tone on demand growth and the need for more supply by the mid-2020’s. Key for 2019 is an expected 35mmtpa of additional supply with Europe and Asia continuing to be the demand drivers. For Europe, LNG represents the biggest source of natural gas supply growth as the region reduces Russian pipeline volumes while China, where LNG imports have doubled over the past two years, remains the focal point for Asia demand. This could be a key part in the U.S.-China trade negotiations as domestic liquefaction capacity increases significantly over the next 3-5 years. Longer-term, RDS/A is forecasting 4% annual LNG demand growth through 2035. On the supply side, 2018 was a big year for new capacity FIDs with 21mmtpa now in progress vs. 7mmtpa FID combined in 2016/17. It’s also possible to see more 2019 FIDs to come in above 2018 as contract length is getting extended and the long-term demand outlook showing potential shortages by the mid-2020’s.
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