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.
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