Outlook for the Upstream Sector of the Oil and Gas Industry

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1 Outlook for the Upstream Sector of the Oil and Gas Industry VMA Market Outlook Workshop San Diego, CA Spears& Associates Tulsa, OK August 2016

2 Oil market fundamentals remain strong World oil demand is estimated to average 95.3 million bpd in 2016, up 1.5%, and 96.8 million bpd in 2017, up 1.6%. Emerging markets now account for over half of worldwide oil demand and will continue to drive global demand growth. India and China will each see demand growth of 300,000 bpd this year. Even with an additional ~500,000 bpd of post-sanction Iranian output in 2016, global oil supply is expected to grow only 0.5% this year, as reduced output from the US will offset gains elsewhere World Oil Demand (million bpd) Spears & Associates 2

3 The rate of global oil inventory build is has fallen in 2016 as global oil demand growth remains robust and non-opec production continues to fall. At the projected rate of global demand growth it would take ~18 months to deplete the extra 800 million barrels of oil that have been placed in inventory over the past two years. 2.5 World Oil Inventory Change (million bpd) Spears & Associates 3

4 OPEC s overall production capacity has increased only 1.2 million bpd per year since 2012 and limited gains are expected going forward OPEC s surplus capacity (primarily located in Saudi Arabia, Kuwait) will average only 1.5 million bpd in 2016 and 1.3 million bpd in Unplanned outages (primarily Libya, Nigeria) currently exceed 2.0 million bpd OPEC Production Capacity (million bpd) Surplus Capacity Unplanned Outages Production Spears & Associates 4

5 US oil production is projected to drop 9% (860,000 bpd) in 2016 but recover in 2017 Approximately 1,800 oil wells are in the fracklog waiting to be completed once oil prices recover sufficiently (above $50/bbl) US producers will need to start increasing production by the second half of 2018 to fill an emerging gap between demand and supply Offshore Alaska Lower 48 US Oil Production (million bpd) 2.0 Spears & Associates 5

6 Oil prices are expected to gradually rise going forward In the past month oil prices have fallen from ~$50 due to worries about the effect of high product inventories on crude demand. Prices are expected to recover as the market grows increasingly confident of the outlook for continued global oil demand growth, limited oil supply increases and the drawdown of oil inventories beginning in the second half of $100 $90 $80 $70 $60 $50 $40 $30 $20 $10 $0 Spot WTI Price ($/bbl) Spears & Associates 6

7 US gas demand has grown at a 2.4% CAGR since 2012, with 45% of the growth due to the power sector where gas has taken share from coal US gas output is projected to reach 74.8 bcfd in 2016 (up 0.8%) but has not grown since Q Increased gas prices, rising LNG exports and a recovery in drilling activity are expected to lift US gas production 2.2% in US Gas Demand / Production (bcfd) Demand Production

8 US spot gas prices are projected to exceed $3.50/mmbtu by 2020 as gas demand growth continues and gas exports increase. US spot gas prices have recovered to over $2.80/mmbtu after having fallen to around $1.60/mmbtu last spring due to the combination of flush inventories and a mild winter. $5.00 $4.50 $4.00 $3.50 $3.00 $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 US Spot Gas Prices ($/mmbtu) Spears & Associates 8

9 Index US well costs fell 0.2% in Q2 2016, leaving overall well costs 7.9% lower in Q than in the year-ago period. Production equipment costs are down 8.7% over the past year The cost to drill and complete wells is expected to begin to rise 3-6 months after drilling activity begins to recover US Production Equipment Costs (Q = 100)

10 US rig activity is projected to fall ~45% in 2016 before rising ~30% next year The combination of low oil prices (impairing well economics), oil price uncertainty (limiting access to financing), and highly levered balance sheets will limit 2016 E&P spend to just free cash flow for most US operators. Based on the outlook for oil prices, US rig activity is expected to exceed 500 active units by the end of this year. 2,000 1,800 1,600 1,400 1,200 1, US Rig Count Gas Rigs Oil Rigs Spears & Associates 10

11 US completion activity is on track to fall ~55% to about 11,000 oil and gas wells in 2016 An increase in drilling activity, and a drawdown of the ~4,000 wells currently in the fracklog is expected to lift the number of US oil and gas well completions to about 17,000 next year, up over 50%. 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 US New Wells Completed Gas Oil 0

12 Canadian rig activity is projected to fall ~39% in 2016 before rising ~30% in 2017 On a regional basis, there continues to be relative strength in natural gas and gas liquids drilling activity related to deep basin drilling in northwestern Alberta and northeastern British Columbia. Alberta plans to double its carbon tax to C$30 per tonne by In addition there will be a 100 megatonne per annum cap on oil sands emissions (up from 70 million megatonnes) Canada Rig Count Spears & Associates 12

13 Canadian completion activity is projected to fall ~35% to about 3,000 wells in 2016 An increase in rig activity is expected to lift the number of well completions to around 4,300 next year, up ~40%. Around 8,500 oil and gas wells are forecast to be abandoned in 2016, down 18%. 12,000 Canada New Wells Completed 10,000 Gas Oil 8,000 6,000 4,000 2,000 0

14 Drilling activity outside North America is forecast to fall 17% in 2016 then grow 3% in 2017 Drilling activity in the Mid East has been little changed over the past two years (-2%) while South America has fallen 50% during this period. On a regional basis, the change in activity in 2017 is expected to be as follows: Mid East (-1%), the Far East (+5%), Africa (+2%), Europe (-6%), and Central and South America (+9%). 1,400 International Rig Count 1,200 1, Spears & Associates 14

15 Drilling activity outside of North America is on track to fall ~20% to about 9,700 wells in 2016 The primary reason for deferring/delaying projects is the challenge to operator cash flow posed by the investment profile of these projects which typically calls for heavy upfront investment combined with multi-year deferral of revenue. 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 International New Wells Drilled Offshore Land 0

16 The global market for oilfield equipment and services is forecast to total $250 billion in 2016, down from $330 billion last year Based on the outlook for a recover in drilling activity, global spending on equipment and services is expected to approach $300 billion in $500 $450 $400 $350 $300 $250 $200 $150 $100 $50 $0 Global Oilfield Equipment and Service Spending ($ Bil) Spears & Associates 16

17 The global market for surface and subsea equipment is forecast to total $19.5 billion in 2016, down from $24.2 billion last year These market segments include the wellheads and Christmas trees used onshore and offshore. Global spending on surface and subsea equipment is expected to approach $21.0 billion in $25 $20 Surface and Subsea Equipment Market ($ Bil) Surface Subsea $15 $10 $5 $

18 The global rig equipment market is forecast to total $11.0 billion in 2016, down from $17.4 billion last year Global spending on rig equipment is expected to fall ~10% in This market is comprised of the manufacture of complete drilling rigs and rig components top drives, rotary tables, mud pumps, etc. Orders for newbuild and replacement equipment have dropped as utilization and profitability have fallen. $30 Rig Equipment Market ($ Bil) $25 $20 $15 $10 $5 $

19 The global market for manufacturing oil service equipment is forecast to total $1.0 billion in 2016, down from $2.5 billion last year Global spending on oil service equipment manufacturing is expected to be little changed in This market is comprised of the manufacture of equipment - frac trucks, wireline vans, coiled tubing units, etc. used by oilfield service firms at the wellsite. $7 Oil Service Equipment Manufacturing Market ($ Bil) $6 $5 $4 $3 $2 $1 $

20 Observations US oil prices are expected to recover to ~$50/bbl by the end of this year and ~$60 by the end of 2017 as the market becomes more balanced and oil traders begin to anticipate the potential for inventory draws beyond US gas prices will average ~$2.30/mmbtu this year as strong gas demand in the power sector helps to diminish the overhang in gas storage. Gas prices are forecast to average over $3/mmbtu in 2017 as the slowdown in output growth tightens the market. Operator strategy will remain that of protecting balance sheets, spending within cash flow and letting production fall if need be. In the current financing environment operators can not afford to tie up funds in non-productive assets for long periods.