The investment value of oil and gas companies’ stocks is evidenced in a recent Sonecon report. According to the report, on average, US$1 invested in oil and gas stocks in FY 2005 by the two largest public employee pension funds in each of 17 American states was worth US$2.30 in FY 2013; by contrast, US$1 invested in all other assets over the same period was worth US$1.68. The recent oil price slide however, has impacted oil and gas companies.

Global oil prices plunged steeply over the past nine months to a near six-year low. In response, oil and gas companies have employed such cost-cutting measures as reduction in capital expenditure (capex) project deferrals as well as staff layoffs, among others. According to Wood Mackenzie, the result has been a 24% reduction year-on-year in capital costs for the industry. It added that the price required for companies to be cash flow neutral in 2015 was cut by more than US$20 per barrel (US$/bbl) to US$72/bbl; however average oil prices for Q1 2015 were US$53.91/bbl (Brent) and US$48.54/bbl (WTI), data from Energy Information Administration, EIA, reveal.

In its 2014 Global Upstream Performance Review, IHS Energy reported a median loss, including dividends, of 34% for 200 publicly-traded Exploration and Production (E&P) companies as well as Integrated Oil Companies (Figure 1).

Three critical operational metrics show the heavy cost burden on the world’s top oil and gas companies: First, unit capital productivity ― which measures the quantity of oil produced per dollar employed ― has declined significantly. Secondly, the massive growth in upstream capex has not been met with commensurate output, and finally, the growth rate in finding and development costs has outstripped that in cash flow. The EIA reports that, for oil and gas companies listed on United States stock exchanges, finding costs for year 2014 increased by US$2.92 per barrel of oil equivalent, US$/boe.

Integrated Oil Companies

Some global Integrated Oil Companies have restructured their operations away from the restrictive Production Sharing Contracts (PSCs) and Service Contracts (SCs) in order to avail themselves of spiking oil prices. Those contract regimes were entered into when oil prices were as low as US$10/bbl and were meant to guarantee corporate profit margins in exchange for increased production for host countries. Such restructuring however, also exposed the companies’ earnings to the vagaries of oil prices.

According to Reuters for example, in 2009, a US$1/bbl change in the price of Brent would, in sympathy, shift the earnings for Royal Dutch Shell (RDS-A) by US$200 million; by the year 2015, that shift was US$330 (See Table 1).

For ExxonMobil (XOM), there was very little sensitivity ― perhaps because it may still have significant PSC-led operations ― while figures for Chevron (CVX) were unavailable. The impact of the recent oil price slide on these companies would therefore be better appreciated.

That said, the companies have developed massive financial and technical resources over the years to enable them withstand such low oil price regimes. Adjusted first quarter earnings declined 20% and 22% for BP and Total respectively, beating analysts’ expectation; due to size and scope of operation, upstream (Exploration and Production) losses were ameliorated by downstream (Refining and Marketing) performances. In that 2014 Global Upstream Performance Review (Figure 1), for example, global Integrated Oil Companies were the best-performing peer group with a median loss of 6.8%, including a boost from a 5.4% dividend return.

The proposed US$70 billion Royal Dutch Shell-BG deal, one of the largest in almost a decade is also a demonstration of such financial might. There have been media reports that the deal would trigger massive merger and acquisition deals but rivals Total and BP have clearly indicated no pressure whatsoever to make similar deals.

There are also reports that BP, with declining production and significant assets divestment ― perhaps to shoulder liabilities arising from the Macondo oil spill ― may be a target for deals; and ExxonMobil, with the financial muscle as well as its own production-expansion challenges, a possible interested party. Such a deal, if it scales potentially formidable corporate and nationality hurdles, may still face substantial regulatory scrutiny.

International integrateds have not been spared by the oil price decline. PetroChina (PTR) for example, just reported an 82% decline in first quarter profit. However, speculation that the Chinese government is considering industry consolidation has sent shares for both PetroChina and Sinopec (SHI) ― China’s two largest oil explorers ― spiraling higher.

Exploration and Production Companies

Independents, particularly those involved with tight oil resources, have, in the main been responsible for the massive ramp-up in oil output, the so-called “shale boom” that propelled the United States to its highest oil output in about four decades.

That boom however has seen a significant pullback due to falling oil prices. About half the country’s drilling rigs are offline and according to industry estimates, there is a growing inventory of about 3,000 drilled-but-uncompleted (DUC) wells. The Energy Information Administration has projected a production decline in May, of 23,000 barrels per day (bpd) to 1.3 million barrels per day (MMbpd) for the Bakken region of North Dakota; while for Eagle Ford of Texas, output is projected to fall 33,000 bpd to 1.69 MMbpd.

Many of the tight oil operators had borrowed heavily to finance their operations. The steep decline in oil prices has seen a significant dip in the value of assets used as security for the loans; and if the United States Federal Reserve were to effect a rate hike this year, as many financial analysts expect, some of these operators may have refinancing challenges particularly if low oil prices endure. They may then become candidates for deals if they want to stay in business.

ConocoPhillips (COP), the third-largest oil producer in the United States, is however, staking a future in tight oil resources especially in the United States and Canada. The company which has undergone significant restructuring and cost-cutting measures over the past few years, expects to turn a profit with those resources even at US$50/bbl oil prices.

Services Companies

Services companies are usually the first to take a hit in rebalancing measures associated with low oil price regimes and not surprisingly, have figured prominently in early consolidation proposals. The proposed deal between Halliburton (HAL) and Baker Hughes (BHI) was one of the earliest in this regime. Halliburton, which expects to cut costs by US$2 billion through the deal, recently announced a 15% capex reduction for 2015, taking a charge of US$1.2 billion for asset write-downs and personnel cuts. According to data from Argus, the company’s net quarterly income fell 33% while drilling and evaluating income for North American operations fell 71%.

Precision Drilling Corp, one of the largest drilling companies in Canada, announced a 76% decline in first quarter profit and has embarked on staff retrenchment as a cost-cutting measure.

Schlumberger (SLB), one of the largest drilling and oilfield services companies is moving on with cost-cutting measures. It is cutting 11,000 more jobs in addition to the earlier 9,000. In announcing its lowest first-quarter profit in four years, the company reported that net income fell to US$975 million, or US$0.76 a share from year-ago values of US$1.59 billion, or US$1.21 a share.

 According to industry estimates, there is at present, a fairly large number of ultra deepwater drilling units without contract and pressures may come on their operators for further deals if the current low oil price regime becomes protracted.

Outlook

The tenure and degree of the current oil price regime will obviously, determine the viability of many oil and gas companies. Some investors and analysts are already seeing an oil price trough and a quick rebound. Such sentiment however, is not supported by current fundamentals. Additions to the current supply overhang would only exert downward pressures on oil prices.

Saudi Arabia is one of the world’s largest crude oil producers; it also has one of the lowest production breakeven prices for the commodity and its current focus on market share rather than prices will only add to the supply overhang. Last month, in spite of the current global supply glut, the country increased its oil production by 658,000 bpd; and that is almost as much as EIA‘s projected output growth for the United States in 2016.

Iran, in a potential sanctions-busting deal with Russia and China, is expected to ramp-up oil output irrespective of the outcome of the nuclear framework accord. Iraq and Libya are also revving to increase output. The International Energy Agency reports that Iraq upped its output for March to 3.67 MMbpd. All of these countries have large reserves and comparatively low production breakeven prices.

Tight oil operators in the United States may well turn out to be the new global swing producers; at least for as long as profitable resources last. With a massive inventory of profitable DUC wells and the enviable capacity ― through shorter-term operational cycles ― for a very rapid production ramp-up, these operators could easily temper any oil price rebound. For example, according to World Oil, the Eagle Ford shale play in Texas has an inventory of nearly 1,400 DUC wells and which inventory is now the investment focus for operators. About 40% of those wells are said to have production breakeven prices of less than US$30/bbl, and ConocoPhillips, Pioneer Resources, BHP Billiton (BHP), Chesapeake (CHK), Anadarko Petroleum (APC) as well as EOG Resources (EOG) are among the named operators.

The current global oil glut derives in the main, from the steep output by tight oil operators in North America. As crude oil inventory in the United States continues to rise, extra storage facilities are being readied in parts of Canada. The increase is accounted for in part, by operators that hedged their production; while some of those contracts are expiring, new ones are being entered into. The rather sluggish global economic outlook, the sheer size of supply overhang and the potential for a massive ramp-up in output, together point to a rather protracted oil price recovery. Except for a global supply shock ― crises in a major transport and, or production hub, for example ― a sustained, rapid, oil price rebound is unlikely in the near term.

In spite of the current oil price level, Merger and Acquisition (M&A) deals for Q1 2015 declined by 79% year-on-year, Evaluate Energy reports. There has not been a rash of megadeals since the recent one between Royal Dutch Shell and BG. The jury is still out on the ultimate value of deals conducted on such scale. Private equity groups however, are reportedly prepping up their financial armories for acquisitions; but given the theme of recent corporate divestments, smart funds would probably be chasing business units rather than whole companies.