E&P to repeat capital discipline mantra in second quarter results, but OFS could signal price increases
Look for North American oil and natural gas producers to maintain capital discipline message when releasing second quarter results, with oil service operators (OFS) alerting customers that prices for equipment and materials supplies will increase.
Three of the world’s largest OFS companies will release their quarterly results in the coming days, with exploration and production (E&P) companies to follow in the coming weeks. Halliburton Co. is due to report its results on Tuesday, followed by Baker Hughes Co. on Wednesday and Schlumberger Ltd. closes the week. In the meantime, other operators will share their results, including midstreamer Kinder Morgan Inc. on Wednesday.
Factset senior earnings analyst John Butters said the S&P 500 is expected to post its strongest earnings growth overall in more than 10 years. Of the 11 industries covered by Factset, energy “recorded the largest percentage increase in estimated profits (at dollar level) since the start of the quarter at 25.1%” to $ 13.5 billion. dollars against 10.8 billion dollars.
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Due to the loss in the energy complex in 2Q2020, an annual growth rate has not been calculated, he noted.
Yet from March 31 to June 30, Factset estimated that the energy sector “witnessed the fourth largest price increase” of the 11 sectors, up 10.1%. Higher oil prices contributed to the rise, with prices exceeding $ 73 / bbl in 2Q2021.
Revenue growth in the energy sector is also expected to eclipse the 11 S&P sectors, with an estimated increase of 87%. The average 2Q2021 oil price was $ 66.17, or 136% above the 2Q2020 average oil price ($ 28.00), Butters noted.
According to FactSet, four energy sub-sectors are expected to record revenue growth above 30%. The oil and gas sector E&P is expected to jump 178%. Integrated oil and gas (110%), oil and gas refining and marketing (76%), and oil and gas storage and transportation (31%).
The price is not fair
Escalating prices for equipment and supplies will likely be on the agenda of OFS conference calls. Until the end of 2021, E&P will face higher costs for raw materials, “particularly in US markets,” according to analysts at Goldman Sachs. OFS operators should be “able to essentially maintain margins in the current inflationary environment,” said the Goldman team led by Neil Mehta.
Inflation is squeezing businesses across industries with supply chain issues a major factor. Federal Reserve Chairman Jerome Powell at a congressional hearing on Wednesday July 14 said that “inflation has risen considerably and is likely to remain high in the coming months before moderating.”
The producer price index (PPI) rose 1% in June after rising 0.8% in May. The cost of services accounted for almost 60% of the June PPI increase. The Consumer Price Index (CPI), another indicator of inflation, also rose in June, reaching an annualized rate of 5.4%. The increase in the CPI was the highest since rising 1% in June 2008. Energy prices rose 1.5% in June on stronger demand for air conditioning and air conditioning. more trips. Gasoline prices rose 2.5%.
Something must give way, however, as OFS operators have relied on cannibalization of equipment to support the missing parts in the Lower 48 for several quarters. According to the Goldman team, taking spare parts from one field to use in another is nearing completion. This could lead to an “improved outlook for orders” for drilling equipment by the end of this year and early 2022.
OFS Trend Online
The Tudor, Pickering, Holt & Co. (TPH) analyst team do not expect “much profit fireworks” when the results are released. Oilfield activity in the US and overseas has improved, but is “essentially in line with the company’s past forecasts and our expectations.”
Collectively, TPH analysts said, OFS stocks are “in the middle of a record run”, with 2Q2021 likely marking “the third consecutive quarter of positive performance.” This has not happened since mid-2014, analysts noted. And unless there is a significant change in the macro crude prices, “we don’t see the carpet retreating below the group in the near term …”
Morgan Stanley & Co. LLC analysts said the second quarter could begin a “new cycle” for the OFS industry. Similar to the sentiments of the TPH team, however, few surprises are expected.
“The long-awaited international recovery is finally on the horizon, but it seems well understood and ruled out for most large service companies,” said Connor Lynagh, Daniel Kutz and Thomas Claes Johnson of Morgan Stanley.
“It became evident this year that the growth engine of upstream investment was likely to shift from more marginal geographies,” including North America and Latin America, and back to the “core” members of the Organization. of oil-exporting countries, aka OPEC. “It has been a bit slow to unfold, but we expect Schlumberger and Halliburton to reiterate their double-digit annual growth targets for the second half of 2021.”
Inflation is likely to be a hot topic, but it’s “not a big deal for OFS margins” as North American pricing is now the benchmark.
“None of the OFS players we spoke with over the past month suggested that they were struggling to pass inflation on to customers,” Morgan Stanley analysts said. “This does not mean that everything is going to beat on the margins, but it does show a tightening of the supply-demand balance for services.”
Arguments can be made for “modest price increases” in North American markets through the end of the year and through 2022.
“We think this is more and more the basic expectation of the market. However, we believe the 2022 E&P budget revisions will be more important in boosting sentiment for North American services, but we’re not sure this quarter brings much clarity on that point. “
Capital discipline is always a thing
Goldman analysts said US producers would likely report that they are still disciplined on capital, “not just for the remainder of this year, but also into 2022.” Even with an average 20% year-to-year increase in capital expenditure (capex) by U.S. producers, frugality remains the message, Mehta said.
“We don’t think public E&P are likely to deviate from this dynamic, especially after years of investor criticism for spending too much cash and failing to return cash to shareholders.”
That said, private E&P can provide some ‘upside’, particularly in the Permian Basin and the Haynesville Shale. Soldiers “currently represent just over 50% of the number of active platforms, compared to 37 to 40% in the past.
“At current commodity prices, we believe that private E&P could have an incentive to increase their activity levels until the end of the year and until 2022.”
Even with oil prices “comfortably” above $ 70 West Texas Intermediate, analysts Silvio Micheloto and Vicent Lovaglio of Mizuho Securities USA LLC expect E&P to focus on cash returns.
“Two quarters of rising oil prices have strengthened balance sheets, while the E&P of our hedge continue to trade at average to high free cash flow yields in 2022 on the Strip. We believe that the cash yield is the bridge to a higher valuation. “
For the first time this year, the Mizuho team said it had shifted its preferences towards natural gas E&P over oil-focused producers. This is because analysts model “a higher potential capacity to pay and believe there is a greater short-term rise in Henry Hub.”
Mizuho raised its price targets for natural gas E&P by 23%, with oil targets 8% higher. “We are seeing an average increase of 35% in gas names, 31% in oils and 29% in refiners.”
Wells Fargo’s equity analyst team led by Nitnin Kumar and Joseph McKay said, “Shale 3.0 has arrived” across the E&P industry with quality and efficiency now driving results.
“Accelerated by a global pandemic, a majority of E&P operators are increasingly adopting our Shale 3.0 framework,” which advocates moderate growth and free cash flow (FCF) generation, analysts at Wells Fargo said.
Like the Mizuho team, analysts said they also see value in natural gas-focused E&P.
“Despite the optimism presented by a significantly higher commodity band in 2021, gas-focused operators continue to talk about discipline in terms of planning and capital allocation,” Kumar and McKay said. “While recognizing the weather / seasonal risks to demand over the summer, we find that gas supply in the US is fundamentally limited and is expected to decline until 2023, while demand is expected to remain relatively resilient. . “