A synchronized uplift in capital deployment

With the recovery definitely underway, Evercore ISI predicts global E&P spending to rise 7% in 2018 following a 4% increase in 2017 and a 33% decline in 2016. Global capex is expected to be up 12% from the 2016 trough, but still down 41% from the 2014 peak. North America will lead the 2018 charge, with estimated capex up 14% from 2017, an increase of 67% from the 2016 bottom, but down 48% from the 2014 high. 

In the U.S., capex will increase 15%, with 2018 spending projected to be up 71% from the 2016 low point, but still down 41% from the 2014 peak. Canadian spending is forecast to increase 9%, up 47% from the 2016 trough, but still 69% less than expenditures from the 2014 summit, Table 1. 

International spending is projected to increase 4% in 2018 following a 6% fall in 2017. The pace of international spending declines moderated in 2017, as incrementally higher activity levels were offset by continued pricing pressure, Table 2. 

Overall, 2018 is on course to mark the first year that all three regions have increased upstream spending concurrently since 2014, a welcome change, particularly for those OFS providers with appreciable exposure to international land/offshore. Although spending will increase, it will not safeguard adequately against a looming supply shortfall.

Supply constriction. After three consecutive years of languishing commodity prices that underwhelmed E&P expectations, improved fundamentals have fostered steady price growth in the back half of 2017. A continuation of this trend in 2018 could yield a commodity landscape that actually outperforms what we believe to be conservative projections for crude. 

Spending caveat. Rapidly changing crude prices can impact spending plans quickly. Anecdotally, we have received feedback from industry sources that suggest that E&Ps are “itching to increase spending,” with WTI grinding to $60/bbl and beyond. Furthermore, we believe that higher-than-expected pricing increases will serve as the basis for E&P investment in excess of currently anticipated capex levels, especially if commodity prices continue to climb. 

Cash flow remains the leading determinant of budgetary decisions in 2018. This factor, along with oil prices, has ranked as number one or two over the past nine years since 2010, following an 11-year stretch, where natural gas prices dominated. 

Service pricing generally rebounded across the board in 2017, as providers began reversing pricing concessions ceded during the downturn. However, pricing across most categories and regions remains well below peak levels, and margins have yet to recover to sustainable levels. Nevertheless, nearly two-thirds of respondents are not factoring in additional cost inflation into their 2018 budgets. This seems like wishful thinking, considering leading-edge pricing has generally trended above average from 2017, especially for North America-land products and services. In the 2017 survey, nearly half of all respondents were budgeting for flat service pricing for the year, a practice that proved to be ill-conceived and fiscally irresponsible. No respondents are budgeting for lower service pricing in 2018, with approximately 37% planning for higher service costs in 2018, although the majority are expecting only minor inflation (10%).

Exploration starting to recover. It appears that exploration spending bottomed in 2016, at least in the U.S., and should continue to recover slightly in 2018. About 29% of respondents increased their exploration capex in 2017, which more than offset the 14% that decreased spending. For 2018, 24% of respondents plan to increase exploration capex relative to their 2017 budgets, which more than offsets 17% that plan to decrease spending. 

Offshore recovery. While the U.S. clearly leads with a modest recovery in exploration spending, a rebound offshore internationally does not appear to be an imminent event. The exploration economics of international regions is generally split evenly between fair and poor at 47% (vs. 38% a year ago) with a modest 7% of our survey citing international exploration economics as good. This is down from 23% last year despite the sharp ramp up in Brent oil prices, and suggests exploration spending could remain relatively flat at the current low levels.

REGIONAL BREAKDOWN

North America looks to continue its upward capex trend after a 48% improvement during 2017. Just as operators scaled back quickly with falling commodity prices in 2015/2016, the short-cycle nature of shale development has served as the basis for a robust up-cycle. While spending levels were still down over 50% from 2014 levels, the increased well complexity and completion intensity make it feel like the industry is approaching peak activity levels. Likewise, 2018 will be another strong year for North America, up 14% for 2018, headlined by continued pricing increases in completion-related services and accelerated bifurcation of the land drilling market. 

U.S. onshore. The Permian continues to be the focal point for capex investment, with nearly 53% of the active oil rigs operating in the Midland/Delaware basins. We expect this trend to continue. However, a broader-based U.S. land up-cycle is underway. We are increasingly optimistic that the SCOOP/STACK is U.S. shale’s “next best thing,” from an overall activity standpoint and from a service intensity perspective. The average STACK, and Cana Woodford, are below a $40/bbl WTI break-even, and are among the more economical plays among U.S. shales. 

Canada. On Nov. 21, the Canadian Association of Oilwell Drilling Contractors (CAODC) released its 2018 drilling forecast, which predicted an increase of 1.8% in the number of wells drilled (6,138 vs 6,031 in 2017). The biggest hurdles in Canada is the lack of market access and regulatory stability with three major infrastructure projects cancelled or delayed in the past six months. 

Evercore ISI believes that Canadian spending will increase by only 9%, as majors/IOCs commit increasingly to the hottest shale basins in the U.S. Also, Canadian spending is more levered to natural gas/condensate prices, in addition to the seasonality of the winter drilling period.

Middle East. Evercore ISI expects Middle Eastern spending to have fallen 10% in 2017, compared to 2016, which saw a 4% improvement in spending. In 2018, the level of capex targeting natural gas development is encouraging, as this has been a source of incremental upside beyond an already robust oil-focused capex profile. Saudi Arabia continues to lead the basket on an absolute capex basis with a 9% increase slated for 2018. ADNOC, KOC, and QPC will also contribute to the increase with 10%, 5%, and 21% gains, respectively. The region’s outlook is dominated by the most recent OPEC/non-OPEC agreement extension, which will continue the 1.2 MM-bbl adjustment through the end of 2018.

Russia/FSU. A lesser-known shale revolution has been unfolding in Russia, and the rapid adoption of horizontal/multi-lateral drilling techniques will yield a steady near-term capex growth in Russia/FSU. As a leading oil and gas producer, the Russian productive base is so vast (and decline rates are so high) that the key operators are required to commit substantial sustaining and greenfield capex, even with moderated OPEC/non-OPEC output. In 2017, capex growth of 12% appears likely, with an appreciable 8% increase targeted for 2018. Spending has remained resilient in the region, due to attractive break-even economics and a favorable energy tax regime. Our 2018 Russia/FSU capex growth is predicated on investment from key players, including +5% from (recently-privatized) Rosneft, +20% from Gazprom (in response to escalating gas demand in Europe/China/Southeast Asia), and +6% from Lukoil. Together, these three companies account for ~75% of the combined budget for the Russia/FSU basket.

Latin America. While activity has largely bottomed across the region, the expected bounce off the bottom is mostly muted. The region should experience a 4% increase in capital spending in 2018, the lowest sequential increase for any region besides Africa. Increasing geopolitical instability and falling production heighten the importance of increased investment to restore some form of social normalcy going forward after a 43% decline in spending in 2016, and a 22% decline in 2017. PDVSA and YPF will again decrease capital spending, but we expect increases from each of the other NOCs in the region with PEMEX posting the largest absolute increase.

Europe. At mid-year, we predicted European investments would contract for a third consecutive year. However, regional operators reversed trends and increased activity, resulting in a 5% increase in spending. Operator OMV Group led with a 30% increase in 2017, and we anticipate another 20% increase in 2018. Statoil and Eni increased spending by mid-single-digit levels. European spending is expected to increase 6% in 2018, but spending could accelerate more than we anticipate, driven by private and independent operators.

Asia/Australia. Current estimates show 2017 being relatively flat, with a 1% spending increase among Asian and Australian producers, which is disappointing compared to the 15% estimate at mid-year. Operators have been slow to advance spending, despite the sharp increase in commodity prices, partly due to an overabundance of opportunities and indigenous suppliers, and a further collapse in pricing. With pricing at new lows for rigs and various services, the increase in absolute spending levels could pale in comparison to the increase in overall activity. We expect operators to take advantage of record-low pricing in the coming months.

Africa remains the most challenged geo-region with respect to spending movement, but declines are decelerating. The reduction is due to geopolitical turmoil in key countries and exposure to deepwater activity. We project that 2017 will have declined 11% from 2016, and 2018 will likely exhibit another step downward, as spending by Sonangol (Angola) and Sonatrach (Algeria) is projected to fall 47% and 8%, respectively. However, a 6% increase is projected for Nigerian National Petroleum Corp. These regional bellwethers continue to suffer from precarious budgeting, scandal and, in some cases, militant destruction and theft of production.