UBS | US E&Ps cut capex by ~40% YoY in 2015 & are budgeted to cut >50% YoY this year. This has caused the US oil rig count to plunge from a peak of 1,609 in 2H14 to 328 (7- year low). But as spot WTI prices have moved from <$30/Bbl earlier this year to ~$46/Bbl currently, one of the key questions energy investors are asking is when will US E&Ps begin to add rigs?
Based on 1Q16 conference call commentary, we believe the “magic” oil price needed to increase drilling activity for US E&Ps is ~$50/Bbl. However, US E&Ps (in our coverage) are tracking to have operating cash flow match capex this year under strip prices (100% plowback ratio), and many E&Ps need to first shore up balance sheets & be confident WTI is sustainably >$50 before making incremental rig commitments. Thus, we do not expect a meaningful rig count increase to occur before 2017.
How many rigs are needed to hold US oil production flat in 4Q17 from 4Q16?
From the current low of ~328 US oil rigs (310 onshore), we estimate just 225 oil rigs would need to be added to reach a total of ~550 in early 2017 (535 onshore) to hold 4Q17 US oil production flat with the 4Q16E level of 7.98 MMBbld. In order to generate 0.5 MMBbld of YoY growth in 4Q17, we estimate ~350 incremental rigs would need to be added to reach an overall ~675 oil rigs (660 onshore).
How high of an oil price is needed to support these levels of drilling activity?
Assuming the avg US onshore rig costs ~$110MM per annum and a December 2016E US oil production exit rate of 8.0 MMBbld (2.9 billion Bbls annualized) implies WTI needs to rise by ~$9/Bbl (after adjusting for royalties & production taxes) from the 2016 strip to the low $50s/Bbl in order to generate enough incremental cash flow to support the additional rigs & hold production flat. While our bottom-up analysis for our E&P coverage shows ~$47/Bbl is needed to hold volumes flat next year, these are the most efficient operators in the US. Using similar assumptions, we estimate WTI needs to rise by ~$15/Bbl to $60/Bbl to fund the incremental 350 rigs required to generate 0.5 MMBbld of growth from 4Q16 to 4Q17.
Where will rigs be added first? Which E&Ps are positioned to benefit first?
We believe rigs will first be allocated to the plays with the most attractive economics: Eagle Ford and the sweet spots of the Permian (northern Midland Basin, southern Delaware Wolfcamp and Delaware Bone Spring). The Permian in particular should see more activity given the larger footprint and earlier stage of development than the Eagle Ford or Bakken. E&Ps that look both well positioned on the cost curve & offer attractive relative valuation include: APC, PXD, PE, NBL, & FANG.
E&Ps discounting $65/Bbl and $3.30/Mcf, reflecting sharp rise in O&G prices
We estimate E&Ps need ~$47/Bbl & ~$2.60/Mcf next year to hold volumes flat from 4Q16 & operate within cash flow while discounting a recovery in oil & gas prices to $65/Bbl & $3.30/Mcf, rich vs. the long-dated futures curve of $53/Bbl & $3.07/Mcf. Top picks are PXD and PE; we rate CHK, DNR, DVN, & SWN as Sell.
*Image: Duncan C