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August 23, 2018
Capex needs emerge amid earnings gains for energy producers
By: Tommy Inglesby

Most of the independent exploration and production companies announced their second quarter 2018 earnings in the first two weeks of August. The overall results were positive—with beats on production and cash flow—but most companies saw a share price drop due to guidance issued for the second half of the year.

The market reaction reflected concerns about the industry’s capital spending plans versus its projected growth in production. Most operators raised their guidance for capex spending; on average, capex guidance increased nearly 5 percent. However, most companies forecast production increases of only 1 to 2 percent.1 The growing need for reinvestment to fund this gap seems to be spooking investors.

The quarter was characterized by key elements including:

  • Production beating market expectations across the board, with average oil production 2 to 5 percent higher than anticipated;
  • Higher than expected cash flow, due to higher than forecast realizations and production hits; and
  • Higher than expected capex, due to faster drilling activity, more completions and increasing services costs.

In our conversations with operators, we are hearing about the need to reach the next level of efficiency gains. The gains on drilling efficiency have been tapped; now it’s all about speed, from site clearing to production. This still takes more than 200 days for many operators. Field development plans are still largely paper based exercises and consume enormous time to create and adjust on the fly.

Operators want to “get predictable” and tighten their focus on eliminating the uncertainty around the development plan. They are trying to understand what drives this uncertainty as it relates to production, capex and opex, and to make better use of data to create more robust plans.

Operators are also seeking better access to markets. After years of focusing capital on production, they are shifting large amounts of capital into midstream investments to access end markets. This requires different project management and marketing skills—with some of these skills long-dormant in operators—and they are trying to build or rebuild these skills quickly.

The U.S. oil industry is back, but there are challenges at both ends of the cycle. The remainder of 2018 will be interesting, as we watch to see how operators play this cycle and whether they pursue different courses of action than they did in 2008 or 2014.


Footnote
1 This is an average of the top independent producers in the United States.

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