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PSAC 2016 Forecast Sees No Short-Term Rebound, Possible Upturn in Second Half of 2016


What you see is what you get. Unless, of course, things change. And so it goes in the highly uncertain world of trying to figure out what drilling and spending is going to be for 2016 in what appears to be an extended period of low oil prices. On November 3, the Petroleum Services Association of Canada (PSAC) held its annual Canadian drilling activity forecast session, an important event for oilfield service (OFS) companies trying to figure out how to plan and budget for the upcoming year.

This year PSAC was again joined by the Canadian Association of Petroleum Producers (CAPP), as well as newcomers CIBC World Markets and National Bank Financial (NBF). A mountain of data was presented from four different perspectives. While the outlook in the short term (the rest of 2015 and the first quarter of 2016) is not positive for a number of reasons, macro trends indicate there could be an improvement in oil prices and a subsequent increase in spending by the second half of next year.

Adam Gill, who works in institutional equity research at CIBC, presented an overview of the outlook for the E&P sector and, by default, the opportunities for OFS. The title was “Challenged Times Ahead of Road to Recovery.” The main driver for next year will, of course, be commodity prices. Gill said, “Near-term spending will continue to be constrained until E&Ps gain clarity on price improvements. With that, expect winter 2015/16 drilling be soft and look for improvements in H2/16.”

CIBC sees capital investment in 2016 to be about the same as 2015. Even if prices improve, many producers will focus upon restoring health to their balance sheets, which have come under tremendous pressure since oil prices collapsed. This will divert funds that might have been available for capital expenditures. Senior producers in particular will be spending the next two years deleveraging their balance sheets.

CIBC concludes, “2016 is our expected low in E&P investment. Winter 2015/16 will be muted, given the current price environment, but will improve in H2/16 on expected recovery in oil and gas prices.”

NBF shared many of the same concerns, but built a case for a meaningful recovery next year. Energy services analyst Greg Colman first indicated if 2016 spending was based on the current forward strip for oil on futures markets, it was going to be a long, tough year. If futures markets are to be believed, NBF sees a 17% to 20% reduction in activity and spending in 2016, compared to this year. On October 30, the price of WTI on the Chicago Mercantile Exchange for November 2016 delivery was US$51.81 and only US$54.57 two years out. Discouraging.

But NBF builds a convincing case why material oil price improvements should occur by the second half of next year. The bank figures at current levels of oil drilling in the United States, light tight oil production should be down 1.1 million to 1.3 million barrels per day within a year. Combined with spending reductions in many markets, this alone will make a meaningful dent in the global supply / demand equation. Further, NBF states individual drilling rig efficiency gains demonstrated over the course of 2015 have likely run their course. Further meaningful gains in drilling productivity are unlikely.

The decline in service costs and gains in operational effectiveness will justify greater investment in certain projects next year than invested in 2015. For example, NBF calculates some oil prospects which used to require US$65 a barrel will now generate an acceptable return at US$50 a barrel in many markets. This will stretch producer cash flow further, resulting in more investment in drilling.

In summary, NBF believes in the short term budgets will actually decline, meaning the rest of 2015 and the start of 2016 will show no improvement for OFS. But they do believe by mid-2016 the price of oil will improve and so will spending.

The firm outlines two scenarios in its 2016 drilling forecast. Under the current crude futures pricing strip, wells drilled and meters drilled will decline by 17% next year. This is based on an average WTI price of US$49.53. However, NBF presented another scenario under which WTI would average US$65 a barrel next year. This would result in a 14% improvement in the number of wells drilled and the number of meters drilled. Drilling rig utilization would rise from 22% in the low price scenario to 31% under a higher price scenario. Obviously, everyone hopes NBF is right.

The NBF presentation ends with the bank pointing out the global crude surplus is much more narrow than it was during 1986 to 1993, a time of very low activity globally. When prices collapsed in 1986, OPEC additional capacity was about 15% of global oil demand, some 10 million barrels a day. Today, OPEC’s spare capacity is only 2.5% of global oil demand, causing NBF to conclude, “Current spare capacity likely does not exist to replicate this extended glut (from the mid 1980s).”

This year CAPP commented on the overall challenges and investment climate as well as provide big picture figures on 2016 spending. Explaining the changing political landscape is appropriate the number of variables which could affect investment decisions in Canada in 2016, factors that have nothing to do with the price of oil or industry reinvestment ratios.

CAPP presented several slides indicating the massive positive economic impact a healthy and investing upstream petroleum industry has on Alberta and the nation. Fiscal and economic policy manager Ben Brunnen estimated the total Alberta oil and gas participation and supply chain was comprised of over 20,000 companies of all types. Besides royalties, the industry last year paid $1.1 billion in municipal property taxes, nearly $1 billion in provincial corporate income taxes, almost $650 million in mineral titles and fees and $83 million in carbon taxes. Then CAPP pointed out there have recently been $500 million in announced increases in provincial corporate income taxes, carbon taxes, and municipal taxes.

CAPP noted the U.S., which used to be our biggest customer, is now our biggest competitor because of massive growth in light tight crude oil and natural gas production. Canadian natural gas exports to the U.S. have been sliding for seven years. The producer association hoped there would be breakthroughs in market access through new oil pipeline construction and that some of the many proposed LNG projects would proceed.

But in the short term, CAPP said the major issues requiring resolution are Alberta’s royalty review, Alberta / British Columbia / federal climate policy and federal government policy under the new Liberal administration.

As for spending CAPP estimates total capital spending in 2016 will decline from an estimated $48 billion in 2015 to $42 billion next year. Oilsands said spending will fall from $23 billion this year to $21 billion next year mainly on the strength of as yet uncompleted projects.Conventional spending will fall even further, percentage-wise, from $21 billion in 2015 to only $18 billion in 2016. To illustrate the gravity of the reduction the 2014 figures were $33 billion for oilsands and $42 billion for conventional. Overall estimated CAPEX of $42 billion in 2016 will be down nearly 50% from $81 billion in 2014. CAPP estimates wells drilled will declined to 4,800 next year compared to 5,320 in 2015.

PSAC President and CEO Mark Salkeld closed the program with a summary of 2015 drilling and the estimates for next year. Last year at this event in late October 2014, before the disastrous OPEC meeting of November 25, PSAC had originally forecast 10,100 wells for 2015. One year later, that figure has been revised downwards to 5,340.

For 2016, PSAC presented an outlook that is for the most part flat, on a year-over-year basis. The association used US$53 as an oil price and C$2.75 per thousand cubic feet as the average price for gas. PSAC forecast 5,150 wells would be drilled on a rig-released basis in Canada next year, a decline of 190 wells from 2015. All provinces would be flat or down slightly, except Manitoba which will see an upturn. As usual nowadays, the vast majority of the wells will be horizontal.

In terms of meters drilled, PSAC actually sees more drilling as the average length of each wellbore drilled rises from 2,650 metres from 2500 metres in 2015. Meters drilled will increase to 13.6 million from 13.4 million. Rig operating days will fall to about 58,000 next year from 61,000 this year. These figures reflect continued gains in drilling productivity. It took an average of 11.4 days to drill each well this year, a figure falling to 11.3 days per well next year, even though the length of each wellbore will increase.

As PSAC demonstrated in its mea culpa to the audience regarding last year’s forecast, predicting drilling and spending in the current volatile oil price market is accompanied by significant risk and room for error. The fact NBF presented two forecasts – one on what we know today based on futures prices and another  illustrating what could happen, based on emerging trends in production declines and spending reductions. This reinforces no one really knows with certainty what the future will bring. CAPP’s cautionary remarks on macro energy policy uncertainties at the present time make rubbing the crystal ball for next year even more challenging.

But there was near unanimity on the short-term outlook, defined as through to spring break up in Q2 2016. Oil companies are going into budgeting season knowing they are unable to hedge future production at materially higher prices, many are overleveraged with their lenders based on current reserve valuations and cash flow and there is a new level of uncertainty at the federal and provincial public policy level.

So, as the old saying goes, plan for the worst and hope for the best.