It’s hard to imagine that 2016 can be much worse than 2015 for the oil and gas , but according to a new report from Oppenheimer Equity Research, this year could be even more painful for the energy sector.
Oppenheimer analysts Fadel Gheit and Luis Amadeo say that things may look bad now, but most energy sector analysts and execs still have overly optimistic expectations for oil and gas prices this year. Unfortunately, that means it is is almost inevitable that things get worse in the oil patch before they get better.
Gheit and Amadeo note that the current consensus estimates for oil and gas prices are over 30% above actual prices, at $53/b WTI, $56/b Brent, and $2.94/mcf for natural gas, compared with current strip prices of $39.58/b WTI, $40.20/b Brent and $2.22/mcf natural gas.
Energy sector earnings likely to be revised downward
The analysts suggest that earnings estimates in the energy sector are too high and will be adjusted downwards: “Based on the current oil and gas price forecasts, we think consensus earnings are high and likely to be revised downward on lower commodity prices. Using strip prices, we expect nine of the 15 large E&P companies we cover to have losses in 2015 and all 15 companies to have losses in 2016. The consensus estimates indicate that seven of the 15 companies will report losses in 2015 and eight in 2016.”
Dangerous deficit spending
Gheit and Amadeo also note that capital spending by the majority of E&P companies has been greater than operating cash flow for at least a decade, and this deficit spending has continued or worsened in the last two years as energy prices tumbled. O&G firms have undertaken CAPEX and expense reductions, and seen efficiency gains and well performance improvements, so the deficit has been funded from asset sales and borrowing. They say: “Companies are self-liquidating by living beyond their means with dire consequences.”
Increase in oil and gas sector M&A activity in the second half of 2016
The Oppenheimer report also highlights that capital efficiency (measured by ROACE) has moved downward over the last decade, despite higher oil prices most of the time. Given that M&A activities are relatively ow by historical standards compared with earlier industry cycles, the expectations gap for oil and gas prices obviously remains broad with potential buyers considering lower prices for a longer period, while potential sellers projecting a recovery sooner. Something has to give, and Gheit and Amadeo argue M&A activities are likely to accelerate in the energy sector by the second half of 2016.