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The Negatives Outweigh The Positives On The Oil Forecast From Dallas Fed

There are a few small signs of a turnaround in the U.S. oil patch but conditions are still expected to be challenging for operators and the companies that serve them in 2020. That's the general conclusion of the quarterly survey of the Dallas Federal Reser

Benzinga · 12/30/2019 16:54

There are a few small signs of a turnaround in the U.S. oil patch but conditions are still expected to be challenging for operators and the companies that serve them in 2020.

That's the general conclusion of the quarterly survey of the Dallas Federal Reserve Bank's Energy Survey, a closely watched report that tracks activity in the oil patch.

The few signs for any sort of optimism comes in its company outlook index, which for exploration and production (E&P) firms rose to positive 15.4 from positive 7.6 in the third quarter. But the oilfield service firms' outlook index – the sector of the oil industry that performs a lot of the work in the field and which would be the types of companies hiring a lot of truck drivers – fell to negative 22.4 from negative 14.8. "This suggests modest improvements in outlooks for E&P firms and worsening outlooks for oilfield services firms," the report said. 

It paints a picture of a stable outlook for the companies that are looking for and finding oil and gas while the industry that gets hired to perform a lot of the services takes it on the chin. For example, the input cost index fell to 1.7 from 5.6. That's good news for the E&P companies that hire service firms, but indicates tighter revenues and margins for the oilfield services companies. "Given flat input prices and lower selling prices, the operating margins index plummeted form -24 to -39.7," the Dallas Fed study said.

The survey was drawn from 170 company responses, 111 of which were E&P firms and 59 oilfield services firms. The index, according to the Dallas Fed, represents a number that is calculated by subtracting the percentage of respondents reporting a decrease from the percentage reporting an increase. If more companies report an increase in the activity tied to a particular question, the number is higher than zero. "If the share of forms reporting a decrease exceeds the share reporting an increase, the index will be below zero, suggesting the indicator has decreased over the previous quarter," the report said in spelling out its methodology. 

The study is focused on the Fed's 11th District, which consists of Texas, northern Louisiana and southern New Mexico.

The survey is showing employment to be negatively affected. The aggregate employment index had a third consecutive quarterly decline, according to the survey, dropping to -10 from -8. Aggregate employee hours worked dropped -7.7 from -2.4, "signaling a further drop in employee hours." But pay is holding; the index for aggregate wages and benefits rose to 8.2 from 6.2.

The survey carries a lengthy number of comments submitted by some companies that responded to the survey. One dealt specifically with trucking: "As a small company of two doing trucking for oil and gas companies, [we find that] things are getting tight," the commenter said. "I am concerned that the… requirements for my work are getting more expensive, which only larger trucking companies can financially handle."

Two other key themes can be found in the survey. One is that the low price of natural gas – which at about $2.16/per million cubic feet (Mmcf) is down 28% on the year – is crimping activity in the sector as a whole. Commenters note that excess gas that can't get to market is being flared in the Permian Basin and the low price is impacting investment decisions that will hurt oil activities in the sector; the two can't always be separated. 

"Continued investor discipline is necessary to get oil and gas firms in shape to become cash-flow positive," one commenter wrote. "Capital starvation (and the resulting decrease in capital expenditures) will show that shale production is not an immutable force."

 That same commenter noted something that other analysts have said – the Energy Information Administration (EIA) forecast that U.S. oil production will rise in 2020 to 13.2 million barrels per day (b/d), an increase of 900,000 b/d from average 2019 levels, is too optimistic. The forecast is "too high and materially so," the commenter said.

Those analysts who are seeing less production growth than forecast by the EIA are basing much of their outlook on the expected squeeze in capital spending from financial firms weary of pumping funding into businesses that are profitable enough to (usually) pay their debts but never generate free cash flow. 

But the Dallas Fed's survey on that issue was less apocalyptic about the fate of capital expenditures (capex). Among  all companies that answered the question about spending next year (both E&P and service companies), 59% said spending next year would increase significantly, increase slightly or remain close to 2019 levels. The remainder answered decrease slightly or decrease significantly, with E&P companies more likely to report the first three categories rather than the services category. Among the services companies, 49% reported plans to spend less in 2020.

The quarterly business indicator for capex also was positive. For E&P firms, it stood at 9.1 for the quarter, up from 3.7 in the third quarter. For the expected level of expenditures next year, it was 0.9, up from -4.7 last quarter. 

But again, it was service firms that paint a far bleaker picture. The index measuring capex for the quarter dropped to -22.4 from -10.9 in the third quarter.

And consider how much it's weakened in the last year. Compared to the answers given a year ago, the "all firms" index on capex was -10 compared to -1.3 a year ago. For E&P firms it dropped to -2.9 from flat. For service firms, it plummeted to -23.3 from -3.7. 

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