Moody’s: Outlook for E&Ps remains positive on production, earnings growth

The outlook for global independent exploration and production firms remains positive, buoyed by strong earnings before interest, taxes, depreciation, and amortization (EBITDA), expected to reach 18-22% higher in 2018, according to Moody’s Investors Service in a recent report.

EBITDA will continue to grow strongly over the next 12-18 months, even as commodity prices stay within a moderate range, although higher costs could cut into cash flow.

“We expect the global independent E&P sector to see EBITDA growth in the 18-22% range in 2018, continuing 2017’s robust growth after steep declines in 2015-16,” said Moody’s Vice-Pres. Amol Joshi. “Oil and natural gas production will increase by about 10% on average this year, while commodity prices remain range-bound, but well above onshore breakeven levels.”

Capital efficiency in the global E&P sector is improving as companies have achieved sustained improvements in drilling and completing wells while commodity prices stabilize at moderate levels, Joshi says.

Higher prices have revived capital spending onshore, though most new offshore projects remain uneconomic. Capital spending will increase by about 10% this year, after a 30% increase in 2017, and E&P firms are likely to maintain good access to funding sources.

Meanwhile, activity in mergers and acquisitions will be more strategic after a wave of tactical acquisitions, divestitures, and swaps in 2016-17. Producers with strong balance sheets will seek efficiencies of scale in higher-return basins, while smaller, sometimes over-leveraged firms will look to combine with larger ones to accelerate development. High valuations relative to cash flow will keep financial firms on the sidelines, with strategic mergers or all-stock acquisitions likely to make the most economic sense for E&P companies with similar valuations.

And following a surge in drilling and completion costs last year, E&P capital costs could inflate 10-15% in 2018, cutting into cash flow growth. Oil field services firms are regaining their pricing power, particularly in prolific onshore basins, though large oil and gas producers with significant purchasing power will be able to limit cost increases. Local sourcing of sand, wherever feasible, will limit completion cost increases for companies. E&P firms will also look for cost efficiencies through supply-chain management, drilling mainly in prolific plays, and M&A deals.

Producers debt-funded high-capital spending in 2010-14 to increase production when oil prices were high. While E&P companies have improved efficiencies and reduced costs during the downturn, overall debt balances will remain elevated this year despite stronger cash flow and liquidity, Moody’s says.

Smaller firms have reduced their debt balances through restructurings and bankruptcies, but the largest companies’ aggregate debt balance is still in line with 2014 levels. And although some larger firms have paid down debt, others intend to use their improved cash flow to increase shareholder returns.