James West, Senior Managing Director & Partner, Oil Services, Equipment & Drilling Fundamental Research, Evercore ISI, addressed the unprecedented downturn driven by pandemic-related demand destruction, and COVID-19 logistical issues, during a market outlook webinar hosted by PESA on May 20.
West said many companies in the OFS sector had begun restructuring efforts in the second half of 2019 to reduce costs and make strategic changes. This work has accelerated since March as revenue will be down sharply in the second quarter of 2020. The collapse of oil prices because of the demand decrease led to a dramatic downturn in oilfield activity with projections showing supply exceeding demand and inventory rising to record levels in the second quarter.
West predicts the tide will turn in the coming months. Demand will exceed supply and inventories will draw down by midyear 2020 and fall further through 2021. Stronger demand and reductions in supply have flattened the curve for global oil inventories.
Evercore maintains their Brent forecast of $40 and $50/bbl at year end 2020 and 2021. Record global inventories near 75 days are likely approaching a peak and will fall to 55 days by year end 2020, and 45 days by the end of 2021.
Capital expenditures, which had not fully recovered from the last downturn, are now plummeting again. West said 2020 capex will likely be 55% below the 2014 peak. He forecasts a 40% drop in North American E&P spending in 2020.
Investors have fled the energy sector in pursuit of higher returns driven by other sectors of the economy, indicating industry change is imperative. West said there are still too many companies, assets, management teams and too much debt. He urged massive consolidation.
In 2019, Evercore released “The Pledge for Oilfield Services,” requesting OFS companies embrace disciplined spending and consider returning surplus capital to shareholders. The pledge called for companies to employ returns-based performance goals at the C-suite that will increase intrinsic value in the equity market.
This year, Part Two of the report goes a step further and makes a stronger call for consolidation. West noted the path to value creation is not easy, but service providers catering to E&P customers need to consider greater scale to avoid significant value destruction. In 2019 there were 479 companies with less than 5% market share in all product lines, West said.
His view is that much more work needs to be done to address this, and that companies should consolidate until they have at least a 15-20% market share. At that point, the sector will have a cohesive market environment where companies can achieve pricing efficiencies and generate acceptable returns for investors and stakeholders. West stressed that this is an urgent need within the sector because of the overall debt level.
West reported that the U.S. land rig count was relatively resilient in Q1, declining by 4.2%. Thus far in Q2, the U.S. land rig count fell 39% from Q1 levels. U.S. land rig count is expected to decline by 55% in 2020, with most of the decline occurring in Q2.
Fracking completion activity has largely stopped. The active completion crew count fell below 100 in April and below 50 in May and could be in the 30s within the next few weeks. Pressure pumping utilization will fall quickly in Q2 before improving in Q3.
West believes the bottoming out process has begun with rig count declines starting to shallow out. For U.S. land, he predicts Q2 activity down sharply, Q3 rebounding slightly, and another decline in activity in Q4 as budgets are exhausted.
Offshore activity is typically resilient during oil price shock, but this past cycle shows an unprecedented drop due to early contract terminations. Although operators announced several contract force majeures, rig tender cancellations, and project deferrals in March and April, the pace of these announcements has slowed. According to West, companies going through restructuring will emerge stronger and unencumbered, which will kick off a much-needed consolidation wave in the fragmented offshore drilling industry.
Looking ahead, West sees U.S. oil production settling around 10 million barrels per day with fewer oilfield suppliers and a critical need for technology in the upstream sector. He expects data and digitalization to accelerate during the downturn and for AI machine learning, mobile operations, and the industrial internet of things (IIoT) to play pivotal roles across the oil and gas value chain.
West said there’s great work being done in the OFS sector with digital, innovation and R&D, and there’s an uptick of entrepreneurs in this market focusing on new technologies that can improve efficiency and lower costs.
West recommends increased collaboration on technology between operators and service providers. The goal of implementing technology is to increase efficiency and drive costs to a point where the American oil and gas industry is successful, profitable and attractive to investors and capital markets.
West finished the webinar saying he has a positive, bullish outlook for the industry. There will be a recovery, he envisions a major short- and long-term role for oil and natural gas, and the industry has shown it has the the ability to self-correct and be viable for years to come.
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