Target mkt cap
Saudi All Industries Sector All Industries –All Sectors Saudi Arabia 25 October 2017 January 18, 2010
Oil market update Key themes US non-conventional supply poised to gain in the near term Compliance to OPEC agreement could imply more market share for shale in 2017 Compliance to OPEC agreement remains healthy Beyond 2017, the high “cash required” price for shale at ~$63/bbl, implies that shale is unlikely to sustain the current capex levels
Shale unlikely to sustain current capex rate Sustainability of US non-conventional supply increase remains suspect: US shale production has continued to increase in 2017, filling the gap created by OPEC and non-OPEC supply cuts. There has been an increase in capex by US shale producers post the OPEC agreement, to take advantage of the increase in crude price. As a result of the increased capex, our calculations show that the oil price required by the US shale companies to compensate for this hike in spending, has increased significantly over the last few quarters, despite gains in operating efficiency. The “required cash price per barrel" (see methodology on page 10) to start generating positive cash flow for selected companies (Figure 6), mainly operating out of Permian region, ranged from US$42/bbl to US$85/bbl. As per IEA, US crude oil production is likely to increase by 0.9mb/d in 2018. Consequently, we believe that the shale producers have to accelerate capex spending significantly to increase the production further. Due to the relatively high production decline rate of a shale well in comparison to conventional well and their shorter life spans, shale producers are also required to spend on drilling new wells more regularly to maintain production levels. We believe the investment required by shale producers to achieve this increase in production would pose a big challenge for the industry, given their persistent negative cash flows at current oil price levels and rising interest rates. The recent increase in capex has been driven by rising debt levels for these companies, which is a negative in the current rising interest rate scenario. Thus, given the significantly higher “required cash price” as well as negligible benefits from hedging, we believe the current increase in capex is not sustainable for US shale producers at the current oil prices, in our view. As a result, we believe shale p roduction will come under pressure in the medium term unless oil prices increase, and conventional producers like OPEC should be able to win back the lost market share eventually. Compliance to OPEC agreement could imply continuing market share gain for shale in 2017: In our view, the OPEC agreement to cut production has been instrumental in helping to rebalance the oil market. Given the extension of agreement to restrain production, Shale may win more market share in 2017 as OPEC is unlikely to compete for market share gains and also crude demand is picking up along with global economic activity. Compliance status improves: Based on OPEC’s secondary sources production data of 11 producers, avg. OPEC compliance to cuts remains healthy at ~98% till September. However September data shows that Libya and Nigeria, being exempt from cuts, have seen slight increase in production, resulting in an overall increase in production for the OPEC members. On the other hand, non-OPEC members have significantly reduced production, reaching a compliance level of 118% by August (as per IEA data).
Mazen Al-Sudairi Head of Research Tel +966 11 2119449 [email protected]. Pritish Devassy, CFA Tel +966 11 2119370 [email protected]
Demand: With the global economic growth strengthening, demand for oil is also expected to pick up in the near to medium term. OPEC has raised its oil demand forecast in its September report, reinforcing our view. Trailing twelve month (TTM) vehicle sales grew 4.7% y-o-y at the end of Q2 2017. Vehicle sales continue to be driven by emerging markets (EM), primarily by China (11.6% TTM y-o-y growth) and India (~8.6%).
Please see penultimate page for additional important disclosures. Al Rajhi Capital (Al Rajhi) is a foreign broker-dealer unregistered in the USA. Al Rajhi research is prepared by research analysts who are not registered in the USA. Al Rajhi research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities, an SEC registered and FINRA-member broker-dealer.
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Oil Supply Shale gains market share as production rises amid improved demand The US shale production has continued to gradually increase over the last year. The advent of OPEC agreement which espoused restraining production from OPEC and major non-OPEC producers, resulted in a loss of ~0.5% market share for OPEC members, at a time when demand was picking up. OPEC’s market share loss has turned out to be US Shale producer’s gain. We believe US non-conventional shale firms could continue to increase market share in the near term because: US non-conventional production is still producing oil at lower levels than its past peak production. With higher number of drilled but uncompleted wells (DUC) and improved drilling activities, we expect oil production to continue inching higher for shale producers in the near term, unless oil price declines. According to EIA, DUC wells have reached to 7,048 by end of August, the highest in more than three years. The increasing compliance of OPEC as well as non-OPEC producers with the agreed supply cuts gives shale producers the opportunity to fill the gap thus created in oil supply. Figure 1 Market shares Dec-16
Jan-17
Feb-17
Mar-17
Apr-17
May-17
Jun-17
Jul-17
Aug-17
OPEC
39.1%
38.5%
38.4%
38.3%
38.3%
38.3%
38.7%
38.6%
38.6%
OECD
13.1%
13.2%
13.3%
13.6%
13.4%
13.1%
12.8%
12.8%
12.5%
6.1%
6.3%
6.5%
6.6%
6.6%
6.7%
6.7%
6.8%
7.0%
41.7%
42.0%
41.8%
41.5%
41.8%
41.9%
41.8%
41.8%
41.9%
US non-conv. Others
Source: OPEC, EIA, IEA, Al Rajhi Capital
1,800
18.0
1,600
16.0
1,400
14.0
1,200
12.0
1,000
10.0
800
8.0
600
6.0
400
4.0
200
MMbbl/d
Figure 2 US shale rig count and production*
2.0
0
-
US Oil rig count (LHS)
US production
Source: Baker Hughes, EIA, Al Rajhi Capital. * Crude and other condensates
“Cash required” per barrel is increasing despite improving operating efficiencies. The operating cost per barrel has declined in Q2 2017 (Figure 3) while production increased. However, excluding one company (Energen Corp) from our analysis, which witnessed a steep improvement in operating cost per barrel, the operating cost was down only marginally. Figure 3 below shows the weighted average operating cost per barrel, while Figure 4 shows the operating cost per barrel for all the shale companies in our study.
Disclosures Please refer to the important disclosures at the back of this report.
2
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Figure 3 Weighted average operating cost per barrel (US$)
Figure 4 Top US Shale Oil producers – Op. cost per barrel (US$/bbl) Title: Source:
42.00
40.00
38.00
Q1 Q2 Q3 Q4 Q1 Q2 2016 2016 2016 2016 2017 2017
Please fill in the values above to have them entered in your report Concho Resources Inc. 38.0 34.5 32.7 31.0 29.7
29.1
Energen Corp.
37.6
33.9
34.9
36.1
37.7
30.6
Diamondback Energy
24.2
25.2
21.6
20.5
21.4
19.6
Pioneer natural Resources
47.4
53.8
54.2
54.3
54.0
52.6
RSP Permian Inc.
31.2
31.6
29.0
26.1
27.1
24.8
Whiting Petroleum Corp.
37.3
38.9
40.0
41.4
37.4
36.3
Oasis Petroleum Inc.
44.1
45.7
45.4
44.8
46.1
43.6
Continental Resources Inc.
29.2
29.7
29.7
29.1
28.8
27.6
Parsley Energy
33.4
32.2
30.3
27.1
25.8
27.4
36.00
34.00
32.00
Q2 2017
Q1 2017
Q4 2016
Q3 2016
Q2 2016
Q1 2016
Q4 2015
Q3 2015
Q2 2015
Q1 2015
30.00
Source: Company data, Bloomberg, Al Rajhi Capital
Source: Company data, Bloomberg, Al Rajhi Capital
Despite reduction in operating cost per barrel of US shale producers, driven by improved efficiency, our calculations show that “Cash required per barrel” (Operating profit + depreciation – interest expense – tax expense – capex on drilling and exploration activities) has increased to US$63/bbl in Q2 2017 from US$59/bbl in Q1 2017 (Figure 5 and 6), primarily on account of the increased capex. Within the Permian basin, Diamondback Energy, which is pure play Permian shale producer, has still one of the lowest requirements of cash per barrel of ~US$42/bbl, while Parsley Energy and RSP Permian need ~US$73/bbl and US$70/bbl, respectively to start generating positive free cash flow. Figure 5 Average “cash required per barrel” for major US shale producers (US$/bbl)- for FCF less interest and tax expense
Figure 6 Cash required per barrel for major US shale producers (US$/bbl) - for FCF plus interest and tax expense Title: Source:
65.0
60.0
Q1 Q2 Q3 Q4 Q1 Q2 2016 2016 2016 2016 2017 2017 Weights
Please fill in the values above to have them entered in your report
55.0
50.0
45.0
40.0
35.0 Q4 2015
Q1 2016
Q2 2016
Q3 2016
Q4 2016
Q1 2017
Q2 2017
Source: Company data, Bloomberg, Al Rajhi Capital Weighted average required cash per barrel based on production of major US shale producers to start generating positive free cash flow
Concho Resources Inc.
NM
35
45
38
94
65
17%
Energen Corp.
32
46
53
56
88
85
7%
Diamondback Energy
50
44
47
45
42
42
7%
Pioneer natural Resources
65
57
51
56
58
82
23%
RSP Permian Inc.
54
50
52
55
58
70
5%
Whiting Petroleum Corp.
50
29
88
42
34
47
10%
Oasis Petroleum Inc.
45
45
51
37
47
57
6%
Continental Resources Inc.
27
26
29
37
45
47
20%
Parsley Energy
90
78
73
64
69
73
6%
Source: Company data, Bloomberg, Al Rajhi Capital. * Weights are based on production
If we exclude the impact of interest and tax expenses on the free cash flow, then our calculations show that the cash required per barrel falls, but still remains higher for the companies being covered in the study (Figure 7 and 8).
Disclosures Please refer to the important disclosures at the back of this report.
3
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Figure 7 Average “cash required per Barrel”* for major US shale producers to generate FCF positive
Figure 8 “Cash required per barrel” for major US shale producers (US$/bbl)
Q1 Q2 Q3 Q4 Q1 Q2 2016 2016 2016 2016 2017 2017 Weight
58.0 56.0 54.0
US$/bbl
52.0 50.0 48.0 46.0 44.0 42.0
40.0 Q4 2015
Q1 2016
Q2 2016
Q3 2016
Q4 2016
Q1 2017
Q2 2017
Concho Resources Inc.
63
48
43
43
54
52
17%
Energen Corp
61
37
41
61
78
79
7%
Diamondback Energy
46
40
44
42
39
41
7%
Pioneer natural Resources
73
64
53
56
57
70
23%
RSP Permian Inc.
52
45
47
50
46
59
5%
Whiting Petroleum Corp.
49
32
31
36
33
45
10%
Oasis Petroleum Inc.
42
49
47
36
35
48
6%
Continental Resources Inc.
30
26
28
28
38
44
20%
Parsley Energy
89
77
68
56
58
64
6%
Source: Company data, Bloomberg, Al Rajhi Capital. Weighted average required cash per barrel Source: Company data, Bloomberg, Al Rajhi Capital. * Required cash per barrel increased for based on production of major US shale producers to generate positive cash flow most companies in Q2 due to higher capex. * Weights are based on production
Shale producers need to increase capex to improve production further, which does not look sustainable at the current oil price. Capital expenditure by the shale producers in our study has started to rise after bottoming out in the second half of 2016. The increase in capital expenditure in 2017 can be partially attributed to the gain in crude oil price post the agreement between OPEC and non-OPEC members to curb production. The increased capital expenditure has also led to rising total debt for these companies (Figure 9). Our study shows that this capex is primarily related to development of new wells. The cost of development of an unconventional well in around US$5-8mn, depending on the region and the depth of well. We assumed an average cost of US6mn per well and looked at the new wells completed by these companies on a quarterly basis, and the figure thus arrived was close to the capex figure. Figure 9 Total debt begins to rise as capex increases US$ mn 24,500
US$ mn 4,000
24,000
3,500
23,500
3,000
23,000 2,500 22,500 2,000 22,000 1,500 21,500 1,000
21,000
500
20,500 20,000
FQ1 2015 FQ2 2015 FQ3 2015 FQ4 2015 FQ1 2016 FQ2 2016 FQ3 2016 FQ4 2016 FQ1 2017 FQ2 2017 Total debt
Capex (RHS)
Source: Company data, Bloomberg, Al Rajhi Capital
The higher production decline rate from shale wells and their relatively short life as compared to conventional wells (Figure 10) necessitates continuous capex for maintenance of production rates. We believe the recent increase in capex being spent by the shale producers is due to this. This increase in capex has pushed higher the cash required (per barrel) to turn FCF positive for most US shale producers. At the current oil price environment, we believe that the current rate of capex spending is unsustainable due to higher “cash required” levels. In addition, the ongoing monetary tightening in the US will further put pressure on US shale producers. As per industry source (columbia university study) , a 2% increase in global Disclosures Please refer to the important disclosures at the back of this report.
4
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
interest rates could essentially erase the efficiency gains that shale producers have achieved. As per IEA, US crude oil production is likely to increase by 0.9mb/d in 2018. To achieve this increase in production, shale producers will have to accelerate capex spending. This increase in capex would be a big challenge for the shale producers, in our view, given their persistent negative cash flows at current oil price levels, debt required to fund the capital investment and rising interest rates. Given the high rate of production decline for a shale well, if the producers are not able to continuously invest in capex, production is likely to rapidly decline. Figure 10 Typical production curve for a light tight oil(shale) well compared to conventional well
Source: Oilprice.com, Al Rajhi Capital
Hedging benefit negligible. A look at the US shale producer’s average hedged realization would indicate a marginal increase in gains in Q2 2017 compared to Q1 2017 ($1.8/bbl vs. $0.4/bbl), which is miniscule, in our view. This compares meekly with the numbers for FY15 and FY16 at US$15/bbl and US$9/bbl, respectively. The forward prices for one and two year contracts which have dropped significantly and closely bordering near term/spot price, offer very little benefit. With no meaningful support from hedging as well as concerns over rising capex at the current oil price levels, the FCF scenario for US shale producers remains challenging with all the key players, excluding Diamondback Energy, recording negative FCF in Q2 2017. Some semblance of hope arises from decrease in operating cost per barrel of oil produced (as discussed above) but the quantum is not high enough to rise above the “cash required” level. Figure 11 US shale producer's average realized gain / losses
Figure 12 US shale producer's average realized gain / losses (US$/bbl) Q1 2015
Q2 2015
Q3 2015
Q4 2015
Q1 2016
Q2 2016
Q3 2016
Concho Resources
19.9
11.4
17.4
21.2
31.0
19.8
18.4
Energen Corp.
24.0
15.4
27.2
34.7
1.5
(5.5)
(1.2)
Diamondback Energy
20.4
12.6
15.5
15.3
2.0
(0.2)
(0.1)
Pioneer natural Res.
20.4
13.0
20.5
23.1
17.3
9.0
RSP Permian
27.3
13.5
12.5
13.7
1.2
20.0
Q4 2016
Q1 2017
Q2 2017
4.7
3.0
6.9
(4.2)
(2.0)
0.0
(0.9)
(0.4)
0.9
13.6
10.4
0.8
1.6
0.5
(1.1)
(1.0)
(1.0)
(0.2)
18.0 16.0
US$/bbl
14.0 12.0 10.0 8.0
Whiting Petroleum
4.2
3.3
4.7
6.4
5.5
3.9
5.3
2.8
0.2
0.7
27.2
26.0
19.2
19.8
18.9
8.1
3.3
1.6
(1.9)
(2.1)
NA
NA
NA
NA
5.2
4.0
2.7
(1.5)
0.0
0.0
Weighted average*
16.4
11.1
15.3
17.9
14.4
7.7
8.8
4.3
0.4
1.8
Q2 2017
NA
16.7
Q1 2017
NA
12.3
Q4 2016
NA
15.0
Q3 2016
NA
7.2
Q2 2016
NA
12.4
Q1 2016
NA
Parsley Energy Q4 2015
Continental Res.
2.0
Q3 2015
4.0
Q2 2015
Oasis Petroleum
Q1 2015
6.0
Source: Company data, Bloomberg, Al Rajhi Capital. Calculated is based on weighted average production of major share producers under our sample.
Disclosures Please refer to the important disclosures at the back of this report.
Source: Company data, Bloomberg, Al Rajhi Capital. Calculated is based on weighted average production of major share producers under our sample.
5
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
OPEC compliance healthy, but offset by higher production from Libya and Nigeria: Based on OPEC’s reported production data (secondary sources), OPEC members’ production increased by 88,500 b/d m-o-m in September, primarily led by higher output from Libya and Nigeria, both of which are not part of OPEC production cut agreement. However, excluding Libya and Nigeria, production was marginally lower on a monthly basis, resulting in a slight increase in compliance with the quotas. Compliance with the agreed production cuts improved from 96% in August to 98% in September, mainly supported by Venezuela and Angola. While monthly OPEC production has declined by an average of 4% this year (from October 2016 production level), OPEC exports have fallen more sharply. Average OPEC export data (May till July – latest available period) shows that monthly exports are down an average ~6% from the October 2016 level.
Figure 13 OPEC compliance to agreement January February March
April
May
June
July
Aug
#
Sep
#
2017 Avg.
Algeria
78%
78%
78%
58%
58%
58%
38%
70%
88%
67%
Angola
142%
129%
142%
117%
181%
117%
104%
136%
140%
134%
Ecuador
88%
88%
108%
69%
69%
69%
31%
54%
54%
70%
Gabon
22%
22%
78%
22%
22%
22%
-200%
156%
-11%
15%
Iran, I.R.***
NA
NA
NA
NA
NA
NA
NA
NA
NA
NA
Iraq
53%
67%
62%
67%
39%
29%
34%
47%
31%
48%
Kuwait
98%
98%
106%
98%
90%
98%
105%
105%
107%
101%
Qatar
127%
193%
127%
93%
60%
93%
127%
127%
113%
118%
Saudi Arabia
153%
116%
126%
120%
128%
102%
106%
116%
116%
120%
UAE
38%
60%
74%
60%
60%
60%
53%
70%
76%
61%
Venezuela
18%
18%
39%
49%
71%
28%
39%
135%
189%
65%
105%
90%
100%
95%
95%
77%
75%
96%
98%
86%
Total OPEC 11#
Source: IEA OMR, OPEC OMR, Al Rajhi Capital. (# August and September data based on OPEC report’s secondary data sources ) *** Iran was given a slight increase. # Excluding Equatorial Guinea, which joined OPEC from 25th May, 2017.
Non-OPEC compliance continued to improve: The IEA data (available till August) reveals that non-OPEC producers improved their compliance to the production cuts significantly from the second quarter. The average compliance of the non-OPEC members stood at 118% in August and 68% for the first eight months of the year. Russia, which alone accounts for 54% of the agreed production cut by 11 non OPEC countries, reached 105% compliance in August. Other members, Mexico, Khazakistan and Azerbaijan also significantly improved compliance in the month of August. Figure 14 Non-OPEC compliance to agreement January February
March
April
Compliance May June
July
Aug
2017 Avg.
Azerbaijan
34%
83%
207%
85%
85%
56%
53%
223%
103%
Kazakhstan
42%
-138%
-324%
-218%
-54%
NA
NA
268%
NA
Mexico
73%
79%
71%
77%
79%
91%
112%
170%
94%
Oman
103%
86%
101%
99%
91%
95%
100%
95%
96%
Russia
39%
40%
59%
77%
91%
93%
92%
105%
74%
Others***
14%
-40%
-28%
86%
-13%
-55%
-69%
-39%
-8%
Total
47%
38%
51%
70%
74%
66%
68%
118%
68%
Source: IEA OMR, Al Rajhi Capital. *** Bahrain, Brunei, Equatorial Guinea, Malaysia, Sudan and South Sudan. ^ From IEA October baseline.
Disclosures Please refer to the important disclosures at the back of this report.
6
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Status of oil supply demand and inventories As the chart below shows, the oil market has been slowly moving towards balance since the second half of 2016. The oil market balancing accelerated in 2017 after the OPEC and major non-OPEC producers agreed to limit supply. As a result, US oil inventories have fallen from a high of 25.6% in August 2016 to ~24% currently. The oil market has largely remained under supplied in the last few months, resulting in falling inventory levels, indicating that the OPEC agreement has been mostly successful in balancing the market. However, oil inventory did increase in September as Hurricane Irma led to closure of a number of refineries in the US Gulf coast. Nevertheless, we expect inventories to again slip back once the refineries restart operations. Figure 15 Difference between oil supply and demand; Level of US inventories* 4.0
26%
3.0
25%
2.0
MMbbl/d
24% 1.0 23% 0.0 22% -1.0
Supply-Demand
Aug-17
Mar-17
Oct-16
May-16
Dec-15
Jul-15
Feb-15
Sep-14
Apr-14
20%
Nov-13
-3.0
Jun-13
21%
Jan-13
-2.0
US Inventory / Supply
Source: OPEC, EIA, Al Rajhi Capital. *We do not look at absolute amount of commercial inventories but as % of US production. For all purposes, the data of demand and supply is inclusive of crude and other condensates.
Disclosures Please refer to the important disclosures at the back of this report.
7
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Oil Demand Figure 16 Supply demand data (mmbpd) IEA 1Q15
2Q15
3Q15
3Q16
4Q16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17
Demand
93.8
94.4
96.0
95.7
95.4
95.9
97.1
97.9
95.8
97.6
97.8
96.6
97.9
99.0
98.4
98.5
Supply
95.3
96.4
97.2
97.4
96.7
96.0
97.0
98.3
96.4
97.1
96.4
96.1
97.0
97.7
98.4
97.7
1.5
2.0
1.2
1.7
1.3
0.1
(0.1)
0.4
0.6
(0.6)
(1.3)
(0.5)
(1.0)
(1.3)
0.0
(0.8)
4Q5
1Q16
2Q6
Gap
4Q5
1Q16
2Q6
Jul-17 Aug-17
Source: IEA OMR OPEC 1Q15
2Q15
3Q15
3Q16
4Q16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17
Demand
91.9
92.0
93.9
94.0
94.1
94.0
95.9
96.1
94.5
96.3
96.4
94.7
96.0
97.1
97.2
97.3
Supply
94.2
94.9
95.5
95.9
96.0
94.7
95.6
97.3
95.8
95.9
95.82
95.81
95.74
96.59
97.16
96.75
2.3
2.9
1.6
1.9
1.9
0.7
(0.3)
1.2
1.3
(0.4)
(0.6)
1.1
(0.3)
(0.5)
0.0
(0.5)
4Q5
1Q16
2Q6
Gap
Jul-17 Aug-17
Source: OPEC OMR EIA 1Q15
2Q15
3Q15
3Q16
4Q16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17
Demand
94.2
94.7
96.2
95.5
95.5
96.1
97.6
97.4
95.9
97.7
97.9
96.8
98.2
99.2
98.9
99.0
Supply
95.6
96.6
97.5
97.7
96.8
96.5
97.1
98.3
96.8
97.4
96.8
97.2
97.8
98.3
99.0
98.6
1.4
1.9
1.3
2.1
1.3
0.4
(0.5)
0.9
0.9
(0.4)
(1.0)
0.4
(0.3)
(0.9)
0.2
(0.3)
Gap
Jul-17 Aug-17
Source: EIA STEO Source: IEA, OPEC, EIA, Al Rajhi Capital
Figure 17 World oil demand, supply* and US inventory trend** 100.0
1,400
99.0 1,300
98.0
1,200
96.0 95.0
1,100
94.0
MMbbls
MMbbl/d
97.0
1,000
93.0
92.0
900
91.0
Total Supply
Total demand
Aug-17
May-17
Feb-17
Nov-16
Aug-16
May-16
Feb-16
Nov-15
Aug-15
May-15
Feb-15
Nov-14
800 Aug-14
90.0
U.S. oil inventories (RHS)
Source: EIA, Al Rajhi Capital. * inclusive of crude and other condensates. ** Total US commercial inventory
Disclosures Please refer to the important disclosures at the back of this report.
8
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Figure 18 Healthy improvement in PMI data
Figure 109 Seasonal nature of oil consumption globally* 100.0
56
98.0
54
96.0
MMbbl/d
58
52
94.0
50 92.0
48 90.0
Jul-17
Sep-17
May-17
Jan-17
Mar-17
Nov-16
Jul-16
Sep-16
May-16
Jan-16
Mar-16
Nov-15
Jul-15
Sep-15
May-15
Jan-15
Mar-15
Nov-14
Sep-14
46 88.0 Jan
Feb
Mar
2014
JPM Global Mf g. PMI
Apr 2015
May
Jun
Jul
2016
Aug
Sep
Oct
2017
Nov
Dec
2017E
US ISM Manuf acturing PMI
China Manuf acturing PMI
Source: Bloomberg, Al Rajhi Capital
Source: EIA, Al Rajhi Capital. * Inclusive of crude and other condensates. 2017e as per EIA forecast
Figure 20 Quarterly Global vehicle sales by regions
Figure 111 Regional contribution to global vehicles sales in 2Q17 1%
20
7.0%
18
6.0%
16
5.0%
14
4.0%
12
4%
23%
3.0%
10
2.0%
8
48%
1.0%
6 4
0.0%
2
-1.0%
Asia Pacif ic North America
Af rica & Mid East
Q2 2017
Q1 2017
Q4 2016
Q3 2016
Q2 2016
Q1 2016
Q4 2015
Q3 2015
Q2 2015
-2.0%
Q1 2015
-
24%
Europe Latin America
Global Vehicle Sales growth (ttm) (y-o-y)
Source: Auto Associations, Governments, Bloomberg, Al Rajhi Capital
Disclosures Please refer to the important disclosures at the back of this report.
Asia Pacif ic
Europe
Latin America
Af rica & Mid East
North America
Source: Auto Associations, Governments, Bloomberg, Al Rajhi Capital
9
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
APPENDIX Methodology of calculation of “cash required”. “Cash required” per barrel to start generating positive FCF generally varies from formation to formation, from well to well as well as from producer to producer due to different well economics, drilling techniques and depth of the formation. In simple terms, the “cash required” level is the function of drilling and completion (D&C) well cost and the amount that can be ultimately recovered from a single well. Since the amount of oil produced from the well varies significantly depending on its drilling technology, geology and well depth, we generally see different “cash required” prices within the same shale oil play. While we look at a different approach to calculate the required cash per barrel level for major US shale producers, we derive our cash required level for non-conventional US producers based on a cash basis. We have analyzed the “cash required” (based on operating profit + depreciation – interest expense – tax expense – core capex including only drilling and completion capex but excluding any acquisition capex) spent by these producers under different oil price regimes and derived the minimum required cash per barrel to cover their core spending based on available historical data.
Disclosures Please refer to the important disclosures at the back of this report.
10
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
IMPORTANT DISCLOSURES FOR U.S. PERSONS This research report was prepared by Al Rajhi Capital (Al Rajhi), a company authorized to engage in securities activities in Saudi Arabia. Al Rajhi is not a registered broker-dealer in the United States and, therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence of research analysts. This research report is provided for distribution to “major U.S. institutional investors” in reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). Any U.S. recipient of this research report wishing to effect any transaction to buy or sell securities or related financial instruments based on the information provided in this research report should do so only through Rosenblatt Securities Inc, 40 Wall Street 59th Floor, New York NY 10005, a registered broker dealer in the United States. Under no circumstances should any recipient of this research report effect any transaction to buy or sell securities or related financial instruments through Al Rajhi. Rosenblatt Securities Inc. accepts responsibility for the contents of this research report, subject to the terms set out below, to the extent that it is delivered to a U.S. person other than a major U.S. institutional investor. The analyst whose name appears in this research report is not registered or qualified as a research analyst with the Financial Industry Regulatory Authority (“FINRA”) and may not be an associated person of Rosenblatt Securities Inc. and, therefore, may not be subject to applicable restrictions under FINRA Rules on communications with a subject company, public appearances and trading securities held by a research analyst account.
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Additional Disclosures This research report is for distribution only under such circumstances as may be permitted by applicable law. This research report has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient, even if sent only to a single recipient. This research report is not guaranteed to be a complete statement or summary of any securities, markets, reports or developments referred to in this research report. Neither Al Rajhi nor any of its directors, officers, employees or agents shall have any liability, however arising, for any error, inaccuracy or incompleteness of fact or opinion in this research report or lack of care in this research report’s preparation or publication, or any losses or damages which may arise from the use of this research report. 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The value of any investment or income from any securities or related financial instruments discussed in this research report denominated in a currency other than U.S. dollars is subject to exchange rate fluctuations that may have a positive or adverse effect on the value of or income from such securities or related financial instruments. Past performance is not necessarily a guide to future performance and no representation or warranty, express or implied, is made by Al Rajhi with respect to future performance. Income from investments may fluctuate. The price or value of the investments to which this research report relates, either directly or indirectly, may fall or rise against the interest of investors. Any recommendation or opinion contained in this research report may become outdated as a consequence of changes in the environment in which the issuer of the securities under analysis operates, in addition to changes in the estimates and forecasts, assumptions and valuation methodology used herein. No part of the content of this research report may be copied, forwarded or duplicated in any form or by any means without the prior consent of Al Rajhi and Al Rajhi accepts no liability whatsoever for the actions of third parties in this respect. This research document has been prepared by Al Rajhi Capital Company (“Al Rajhi Capital”) of Riyadh, Saudi Arabia. It has been prepared for the general use of Al Rajhi Capital’s clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Al Rajhi Capital. Receipt and review of this research document constitute your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this document prior to public disclosure of such information by Al Rajhi Capital. The information contained was obtained from various public sources believed to be reliable but we do not guarantee its accuracy. Al Rajhi Capital makes no representations or warranties (express or implied) regarding the data and information provided and Al Rajhi Capital does not represent that the information content of this document is complete, or free from any error, not misleading, or fit for any particular purpose. This research document provides general information only. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other investment products related to such securities or investments. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. Investors should seek financial, legal or tax advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this document and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities or other investments, if any, may fluctuate and that the price or value of such securities and investments may rise or fall. Fluctuations in exchange rates could have adverse effects on the value of or price of, or income derived from, certain investments. Accordingly, investors may receive back less than originally invested. Al Rajhi Capital or its officers or one or more of its affiliates (including research analysts) may have a financial interest in securities of the issuer(s) or related investments, including long or short positions in securities, warrants, futures, options, derivatives, or other financial instruments. Al Rajhi Capital or its affiliates may from time to time perform investment banking or other services for, solicit investment banking or other business from, any company mentioned in this research document. Al Rajhi Capital, together with its affiliates and employees, shall not be liable for any direct, indirect or consequential loss or damages that may arise, directly or indirectly, from any use of the information contained in this research document. This research document and any recommendations contained are subject to change without prior notice. Al Rajhi Capital assumes no responsibility to update the information in this research document. Neither the whole nor any part of this research document may be altered, duplicated, transmitted or distributed in any form or by any means. This research document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or which would subject Al Rajhi Capital or any of its affiliates to any registration or licensing requirement within such jurisdiction.
Disclosures Please refer to the important disclosures at the back of this report.
11
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Disclaimer and additional disclosures for Equity Research Disclaimer This research document has been prepared by Al Rajhi Capital Company (“Al Rajhi Capital”) of Riyadh, Saudi Arabia. It has been prepared for the general use of Al Rajhi Capital’s clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Al Rajhi Capital. Receipt and review of this research document constitute your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this document prior to public disclosure of such information by Al Rajhi Capital. The information contained was obtained from various public sources believed to be reliable but we do not guarantee its accuracy. Al Rajhi Capital makes no representations or warranties (express or implied) regarding the data and information provided and Al Rajhi Capital does not represent that the information content of this document is complete, or free from any error, not misleading, or fit for any particular purpose. This research document provides general information only. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other investment products related to such securities or investments. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. Investors should seek financial, legal or tax advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this document and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities or other investments, if any, may fluctuate and that the price or value of such securities and investments may rise or fall. Fluctuations in exchange rates could have adverse effects on the value of or price of, or income derived from, certain investments. Accordingly, investors may receive back less than originally invested. Al Rajhi Capital or its officers or one or more of its affiliates (including research analysts) may have a financial interest in securities of the issuer(s) or related investments, including long or short positions in securities, warrants, futures, options, derivatives, or other financial instruments. Al Rajhi Capital or its affiliates may from time to time perform investment banking or other services for, solicit investment banking or other business from, any company mentioned in this research document. Al Rajhi Capital, together with its affiliates and employees, shall not be liable for any direct, indirect or consequential loss or damages that may arise, directly or indirectly, from any use of the information contained in this research document. This research document and any recommendations contained are subject to change without prior notice. Al Rajhi Capital assumes no responsibility to update the information in this research document. Neither the whole nor any part of this research document may be altered, duplicated, transmitted or distributed in any form or by any means. This research document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or which would subject Al Rajhi Capital or any of its affiliates to any registration or licensing requirement within such jurisdiction.
Explanation of Al Rajhi Capital’s rating system Al Rajhi Capital uses a three-tier rating system based on absolute upside or downside potential for all stocks under its coverage except financial stocks and those few other companies not compliant with Islamic Shariah law: "Overweight": Our target price is more than 10% above the current share price, and we expect the share price to reach the target on a 12 month time horizon. "Neutral": We expect the share price to settle at a level between 10% below the current share price and 10% above the current share price on a 12 month time horizon. "Underweight": Our target price is more than 10% below the current share price, and we expect the share price to reach the target on a 12 month time horizon. "Target price": We estimate target value per share for every stock we cover. This is normally based on widely accepted methods appropriate to the stock or sector under consideration, e.g. DCF (discounted cash flow) or SoTP (sum of the parts) analysis. Please note that the achievement of any price target may be impeded by general market and economic trends and other external factors, or if a company’s profits or operating performance exceed or fall short of our expectations.
Contact us Mazen AlSudairi Head of Research Tel : +966 1 211 9449 Email: [email protected] Al Rajhi Capital Research Department Head Office, King Fahad Road P.O. Box 5561, Riyadh 11432 Kingdom of Saudi Arabia Email: [email protected] Al Rajhi Capital is licensed by the Saudi Arabian Capital Market Authority, License No. 07068/37.
Disclosures Please refer to the important disclosures at the back of this report.
12
Oil market update Key themes US non-conventional supply poised to gain in the near term Compliance to OPEC agreement could imply more market share for shale in 2017 Compliance to OPEC agreement remains healthy Beyond 2017, the high “cash required” price for shale at ~$63/bbl, implies that shale is unlikely to sustain the current capex levels
Shale unlikely to sustain current capex rate Sustainability of US non-conventional supply increase remains suspect: US shale production has continued to increase in 2017, filling the gap created by OPEC and non-OPEC supply cuts. There has been an increase in capex by US shale producers post the OPEC agreement, to take advantage of the increase in crude price. As a result of the increased capex, our calculations show that the oil price required by the US shale companies to compensate for this hike in spending, has increased significantly over the last few quarters, despite gains in operating efficiency. The “required cash price per barrel" (see methodology on page 10) to start generating positive cash flow for selected companies (Figure 6), mainly operating out of Permian region, ranged from US$42/bbl to US$85/bbl. As per IEA, US crude oil production is likely to increase by 0.9mb/d in 2018. Consequently, we believe that the shale producers have to accelerate capex spending significantly to increase the production further. Due to the relatively high production decline rate of a shale well in comparison to conventional well and their shorter life spans, shale producers are also required to spend on drilling new wells more regularly to maintain production levels. We believe the investment required by shale producers to achieve this increase in production would pose a big challenge for the industry, given their persistent negative cash flows at current oil price levels and rising interest rates. The recent increase in capex has been driven by rising debt levels for these companies, which is a negative in the current rising interest rate scenario. Thus, given the significantly higher “required cash price” as well as negligible benefits from hedging, we believe the current increase in capex is not sustainable for US shale producers at the current oil prices, in our view. As a result, we believe shale p roduction will come under pressure in the medium term unless oil prices increase, and conventional producers like OPEC should be able to win back the lost market share eventually. Compliance to OPEC agreement could imply continuing market share gain for shale in 2017: In our view, the OPEC agreement to cut production has been instrumental in helping to rebalance the oil market. Given the extension of agreement to restrain production, Shale may win more market share in 2017 as OPEC is unlikely to compete for market share gains and also crude demand is picking up along with global economic activity. Compliance status improves: Based on OPEC’s secondary sources production data of 11 producers, avg. OPEC compliance to cuts remains healthy at ~98% till September. However September data shows that Libya and Nigeria, being exempt from cuts, have seen slight increase in production, resulting in an overall increase in production for the OPEC members. On the other hand, non-OPEC members have significantly reduced production, reaching a compliance level of 118% by August (as per IEA data).
Mazen Al-Sudairi Head of Research Tel +966 11 2119449 [email protected]. Pritish Devassy, CFA Tel +966 11 2119370 [email protected]
Demand: With the global economic growth strengthening, demand for oil is also expected to pick up in the near to medium term. OPEC has raised its oil demand forecast in its September report, reinforcing our view. Trailing twelve month (TTM) vehicle sales grew 4.7% y-o-y at the end of Q2 2017. Vehicle sales continue to be driven by emerging markets (EM), primarily by China (11.6% TTM y-o-y growth) and India (~8.6%).
Please see penultimate page for additional important disclosures. Al Rajhi Capital (Al Rajhi) is a foreign broker-dealer unregistered in the USA. Al Rajhi research is prepared by research analysts who are not registered in the USA. Al Rajhi research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities, an SEC registered and FINRA-member broker-dealer.
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Oil Supply Shale gains market share as production rises amid improved demand The US shale production has continued to gradually increase over the last year. The advent of OPEC agreement which espoused restraining production from OPEC and major non-OPEC producers, resulted in a loss of ~0.5% market share for OPEC members, at a time when demand was picking up. OPEC’s market share loss has turned out to be US Shale producer’s gain. We believe US non-conventional shale firms could continue to increase market share in the near term because: US non-conventional production is still producing oil at lower levels than its past peak production. With higher number of drilled but uncompleted wells (DUC) and improved drilling activities, we expect oil production to continue inching higher for shale producers in the near term, unless oil price declines. According to EIA, DUC wells have reached to 7,048 by end of August, the highest in more than three years. The increasing compliance of OPEC as well as non-OPEC producers with the agreed supply cuts gives shale producers the opportunity to fill the gap thus created in oil supply. Figure 1 Market shares Dec-16
Jan-17
Feb-17
Mar-17
Apr-17
May-17
Jun-17
Jul-17
Aug-17
OPEC
39.1%
38.5%
38.4%
38.3%
38.3%
38.3%
38.7%
38.6%
38.6%
OECD
13.1%
13.2%
13.3%
13.6%
13.4%
13.1%
12.8%
12.8%
12.5%
6.1%
6.3%
6.5%
6.6%
6.6%
6.7%
6.7%
6.8%
7.0%
41.7%
42.0%
41.8%
41.5%
41.8%
41.9%
41.8%
41.8%
41.9%
US non-conv. Others
Source: OPEC, EIA, IEA, Al Rajhi Capital
1,800
18.0
1,600
16.0
1,400
14.0
1,200
12.0
1,000
10.0
800
8.0
600
6.0
400
4.0
200
MMbbl/d
Figure 2 US shale rig count and production*
2.0
0
-
US Oil rig count (LHS)
US production
Source: Baker Hughes, EIA, Al Rajhi Capital. * Crude and other condensates
“Cash required” per barrel is increasing despite improving operating efficiencies. The operating cost per barrel has declined in Q2 2017 (Figure 3) while production increased. However, excluding one company (Energen Corp) from our analysis, which witnessed a steep improvement in operating cost per barrel, the operating cost was down only marginally. Figure 3 below shows the weighted average operating cost per barrel, while Figure 4 shows the operating cost per barrel for all the shale companies in our study.
Disclosures Please refer to the important disclosures at the back of this report.
2
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Figure 3 Weighted average operating cost per barrel (US$)
Figure 4 Top US Shale Oil producers – Op. cost per barrel (US$/bbl) Title: Source:
42.00
40.00
38.00
Q1 Q2 Q3 Q4 Q1 Q2 2016 2016 2016 2016 2017 2017
Please fill in the values above to have them entered in your report Concho Resources Inc. 38.0 34.5 32.7 31.0 29.7
29.1
Energen Corp.
37.6
33.9
34.9
36.1
37.7
30.6
Diamondback Energy
24.2
25.2
21.6
20.5
21.4
19.6
Pioneer natural Resources
47.4
53.8
54.2
54.3
54.0
52.6
RSP Permian Inc.
31.2
31.6
29.0
26.1
27.1
24.8
Whiting Petroleum Corp.
37.3
38.9
40.0
41.4
37.4
36.3
Oasis Petroleum Inc.
44.1
45.7
45.4
44.8
46.1
43.6
Continental Resources Inc.
29.2
29.7
29.7
29.1
28.8
27.6
Parsley Energy
33.4
32.2
30.3
27.1
25.8
27.4
36.00
34.00
32.00
Q2 2017
Q1 2017
Q4 2016
Q3 2016
Q2 2016
Q1 2016
Q4 2015
Q3 2015
Q2 2015
Q1 2015
30.00
Source: Company data, Bloomberg, Al Rajhi Capital
Source: Company data, Bloomberg, Al Rajhi Capital
Despite reduction in operating cost per barrel of US shale producers, driven by improved efficiency, our calculations show that “Cash required per barrel” (Operating profit + depreciation – interest expense – tax expense – capex on drilling and exploration activities) has increased to US$63/bbl in Q2 2017 from US$59/bbl in Q1 2017 (Figure 5 and 6), primarily on account of the increased capex. Within the Permian basin, Diamondback Energy, which is pure play Permian shale producer, has still one of the lowest requirements of cash per barrel of ~US$42/bbl, while Parsley Energy and RSP Permian need ~US$73/bbl and US$70/bbl, respectively to start generating positive free cash flow. Figure 5 Average “cash required per barrel” for major US shale producers (US$/bbl)- for FCF less interest and tax expense
Figure 6 Cash required per barrel for major US shale producers (US$/bbl) - for FCF plus interest and tax expense Title: Source:
65.0
60.0
Q1 Q2 Q3 Q4 Q1 Q2 2016 2016 2016 2016 2017 2017 Weights
Please fill in the values above to have them entered in your report
55.0
50.0
45.0
40.0
35.0 Q4 2015
Q1 2016
Q2 2016
Q3 2016
Q4 2016
Q1 2017
Q2 2017
Source: Company data, Bloomberg, Al Rajhi Capital Weighted average required cash per barrel based on production of major US shale producers to start generating positive free cash flow
Concho Resources Inc.
NM
35
45
38
94
65
17%
Energen Corp.
32
46
53
56
88
85
7%
Diamondback Energy
50
44
47
45
42
42
7%
Pioneer natural Resources
65
57
51
56
58
82
23%
RSP Permian Inc.
54
50
52
55
58
70
5%
Whiting Petroleum Corp.
50
29
88
42
34
47
10%
Oasis Petroleum Inc.
45
45
51
37
47
57
6%
Continental Resources Inc.
27
26
29
37
45
47
20%
Parsley Energy
90
78
73
64
69
73
6%
Source: Company data, Bloomberg, Al Rajhi Capital. * Weights are based on production
If we exclude the impact of interest and tax expenses on the free cash flow, then our calculations show that the cash required per barrel falls, but still remains higher for the companies being covered in the study (Figure 7 and 8).
Disclosures Please refer to the important disclosures at the back of this report.
3
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Figure 7 Average “cash required per Barrel”* for major US shale producers to generate FCF positive
Figure 8 “Cash required per barrel” for major US shale producers (US$/bbl)
Q1 Q2 Q3 Q4 Q1 Q2 2016 2016 2016 2016 2017 2017 Weight
58.0 56.0 54.0
US$/bbl
52.0 50.0 48.0 46.0 44.0 42.0
40.0 Q4 2015
Q1 2016
Q2 2016
Q3 2016
Q4 2016
Q1 2017
Q2 2017
Concho Resources Inc.
63
48
43
43
54
52
17%
Energen Corp
61
37
41
61
78
79
7%
Diamondback Energy
46
40
44
42
39
41
7%
Pioneer natural Resources
73
64
53
56
57
70
23%
RSP Permian Inc.
52
45
47
50
46
59
5%
Whiting Petroleum Corp.
49
32
31
36
33
45
10%
Oasis Petroleum Inc.
42
49
47
36
35
48
6%
Continental Resources Inc.
30
26
28
28
38
44
20%
Parsley Energy
89
77
68
56
58
64
6%
Source: Company data, Bloomberg, Al Rajhi Capital. Weighted average required cash per barrel Source: Company data, Bloomberg, Al Rajhi Capital. * Required cash per barrel increased for based on production of major US shale producers to generate positive cash flow most companies in Q2 due to higher capex. * Weights are based on production
Shale producers need to increase capex to improve production further, which does not look sustainable at the current oil price. Capital expenditure by the shale producers in our study has started to rise after bottoming out in the second half of 2016. The increase in capital expenditure in 2017 can be partially attributed to the gain in crude oil price post the agreement between OPEC and non-OPEC members to curb production. The increased capital expenditure has also led to rising total debt for these companies (Figure 9). Our study shows that this capex is primarily related to development of new wells. The cost of development of an unconventional well in around US$5-8mn, depending on the region and the depth of well. We assumed an average cost of US6mn per well and looked at the new wells completed by these companies on a quarterly basis, and the figure thus arrived was close to the capex figure. Figure 9 Total debt begins to rise as capex increases US$ mn 24,500
US$ mn 4,000
24,000
3,500
23,500
3,000
23,000 2,500 22,500 2,000 22,000 1,500 21,500 1,000
21,000
500
20,500 20,000
FQ1 2015 FQ2 2015 FQ3 2015 FQ4 2015 FQ1 2016 FQ2 2016 FQ3 2016 FQ4 2016 FQ1 2017 FQ2 2017 Total debt
Capex (RHS)
Source: Company data, Bloomberg, Al Rajhi Capital
The higher production decline rate from shale wells and their relatively short life as compared to conventional wells (Figure 10) necessitates continuous capex for maintenance of production rates. We believe the recent increase in capex being spent by the shale producers is due to this. This increase in capex has pushed higher the cash required (per barrel) to turn FCF positive for most US shale producers. At the current oil price environment, we believe that the current rate of capex spending is unsustainable due to higher “cash required” levels. In addition, the ongoing monetary tightening in the US will further put pressure on US shale producers. As per industry source (columbia university study) , a 2% increase in global Disclosures Please refer to the important disclosures at the back of this report.
4
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
interest rates could essentially erase the efficiency gains that shale producers have achieved. As per IEA, US crude oil production is likely to increase by 0.9mb/d in 2018. To achieve this increase in production, shale producers will have to accelerate capex spending. This increase in capex would be a big challenge for the shale producers, in our view, given their persistent negative cash flows at current oil price levels, debt required to fund the capital investment and rising interest rates. Given the high rate of production decline for a shale well, if the producers are not able to continuously invest in capex, production is likely to rapidly decline. Figure 10 Typical production curve for a light tight oil(shale) well compared to conventional well
Source: Oilprice.com, Al Rajhi Capital
Hedging benefit negligible. A look at the US shale producer’s average hedged realization would indicate a marginal increase in gains in Q2 2017 compared to Q1 2017 ($1.8/bbl vs. $0.4/bbl), which is miniscule, in our view. This compares meekly with the numbers for FY15 and FY16 at US$15/bbl and US$9/bbl, respectively. The forward prices for one and two year contracts which have dropped significantly and closely bordering near term/spot price, offer very little benefit. With no meaningful support from hedging as well as concerns over rising capex at the current oil price levels, the FCF scenario for US shale producers remains challenging with all the key players, excluding Diamondback Energy, recording negative FCF in Q2 2017. Some semblance of hope arises from decrease in operating cost per barrel of oil produced (as discussed above) but the quantum is not high enough to rise above the “cash required” level. Figure 11 US shale producer's average realized gain / losses
Figure 12 US shale producer's average realized gain / losses (US$/bbl) Q1 2015
Q2 2015
Q3 2015
Q4 2015
Q1 2016
Q2 2016
Q3 2016
Concho Resources
19.9
11.4
17.4
21.2
31.0
19.8
18.4
Energen Corp.
24.0
15.4
27.2
34.7
1.5
(5.5)
(1.2)
Diamondback Energy
20.4
12.6
15.5
15.3
2.0
(0.2)
(0.1)
Pioneer natural Res.
20.4
13.0
20.5
23.1
17.3
9.0
RSP Permian
27.3
13.5
12.5
13.7
1.2
20.0
Q4 2016
Q1 2017
Q2 2017
4.7
3.0
6.9
(4.2)
(2.0)
0.0
(0.9)
(0.4)
0.9
13.6
10.4
0.8
1.6
0.5
(1.1)
(1.0)
(1.0)
(0.2)
18.0 16.0
US$/bbl
14.0 12.0 10.0 8.0
Whiting Petroleum
4.2
3.3
4.7
6.4
5.5
3.9
5.3
2.8
0.2
0.7
27.2
26.0
19.2
19.8
18.9
8.1
3.3
1.6
(1.9)
(2.1)
NA
NA
NA
NA
5.2
4.0
2.7
(1.5)
0.0
0.0
Weighted average*
16.4
11.1
15.3
17.9
14.4
7.7
8.8
4.3
0.4
1.8
Q2 2017
NA
16.7
Q1 2017
NA
12.3
Q4 2016
NA
15.0
Q3 2016
NA
7.2
Q2 2016
NA
12.4
Q1 2016
NA
Parsley Energy Q4 2015
Continental Res.
2.0
Q3 2015
4.0
Q2 2015
Oasis Petroleum
Q1 2015
6.0
Source: Company data, Bloomberg, Al Rajhi Capital. Calculated is based on weighted average production of major share producers under our sample.
Disclosures Please refer to the important disclosures at the back of this report.
Source: Company data, Bloomberg, Al Rajhi Capital. Calculated is based on weighted average production of major share producers under our sample.
5
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
OPEC compliance healthy, but offset by higher production from Libya and Nigeria: Based on OPEC’s reported production data (secondary sources), OPEC members’ production increased by 88,500 b/d m-o-m in September, primarily led by higher output from Libya and Nigeria, both of which are not part of OPEC production cut agreement. However, excluding Libya and Nigeria, production was marginally lower on a monthly basis, resulting in a slight increase in compliance with the quotas. Compliance with the agreed production cuts improved from 96% in August to 98% in September, mainly supported by Venezuela and Angola. While monthly OPEC production has declined by an average of 4% this year (from October 2016 production level), OPEC exports have fallen more sharply. Average OPEC export data (May till July – latest available period) shows that monthly exports are down an average ~6% from the October 2016 level.
Figure 13 OPEC compliance to agreement January February March
April
May
June
July
Aug
#
Sep
#
2017 Avg.
Algeria
78%
78%
78%
58%
58%
58%
38%
70%
88%
67%
Angola
142%
129%
142%
117%
181%
117%
104%
136%
140%
134%
Ecuador
88%
88%
108%
69%
69%
69%
31%
54%
54%
70%
Gabon
22%
22%
78%
22%
22%
22%
-200%
156%
-11%
15%
Iran, I.R.***
NA
NA
NA
NA
NA
NA
NA
NA
NA
NA
Iraq
53%
67%
62%
67%
39%
29%
34%
47%
31%
48%
Kuwait
98%
98%
106%
98%
90%
98%
105%
105%
107%
101%
Qatar
127%
193%
127%
93%
60%
93%
127%
127%
113%
118%
Saudi Arabia
153%
116%
126%
120%
128%
102%
106%
116%
116%
120%
UAE
38%
60%
74%
60%
60%
60%
53%
70%
76%
61%
Venezuela
18%
18%
39%
49%
71%
28%
39%
135%
189%
65%
105%
90%
100%
95%
95%
77%
75%
96%
98%
86%
Total OPEC 11#
Source: IEA OMR, OPEC OMR, Al Rajhi Capital. (# August and September data based on OPEC report’s secondary data sources ) *** Iran was given a slight increase. # Excluding Equatorial Guinea, which joined OPEC from 25th May, 2017.
Non-OPEC compliance continued to improve: The IEA data (available till August) reveals that non-OPEC producers improved their compliance to the production cuts significantly from the second quarter. The average compliance of the non-OPEC members stood at 118% in August and 68% for the first eight months of the year. Russia, which alone accounts for 54% of the agreed production cut by 11 non OPEC countries, reached 105% compliance in August. Other members, Mexico, Khazakistan and Azerbaijan also significantly improved compliance in the month of August. Figure 14 Non-OPEC compliance to agreement January February
March
April
Compliance May June
July
Aug
2017 Avg.
Azerbaijan
34%
83%
207%
85%
85%
56%
53%
223%
103%
Kazakhstan
42%
-138%
-324%
-218%
-54%
NA
NA
268%
NA
Mexico
73%
79%
71%
77%
79%
91%
112%
170%
94%
Oman
103%
86%
101%
99%
91%
95%
100%
95%
96%
Russia
39%
40%
59%
77%
91%
93%
92%
105%
74%
Others***
14%
-40%
-28%
86%
-13%
-55%
-69%
-39%
-8%
Total
47%
38%
51%
70%
74%
66%
68%
118%
68%
Source: IEA OMR, Al Rajhi Capital. *** Bahrain, Brunei, Equatorial Guinea, Malaysia, Sudan and South Sudan. ^ From IEA October baseline.
Disclosures Please refer to the important disclosures at the back of this report.
6
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Status of oil supply demand and inventories As the chart below shows, the oil market has been slowly moving towards balance since the second half of 2016. The oil market balancing accelerated in 2017 after the OPEC and major non-OPEC producers agreed to limit supply. As a result, US oil inventories have fallen from a high of 25.6% in August 2016 to ~24% currently. The oil market has largely remained under supplied in the last few months, resulting in falling inventory levels, indicating that the OPEC agreement has been mostly successful in balancing the market. However, oil inventory did increase in September as Hurricane Irma led to closure of a number of refineries in the US Gulf coast. Nevertheless, we expect inventories to again slip back once the refineries restart operations. Figure 15 Difference between oil supply and demand; Level of US inventories* 4.0
26%
3.0
25%
2.0
MMbbl/d
24% 1.0 23% 0.0 22% -1.0
Supply-Demand
Aug-17
Mar-17
Oct-16
May-16
Dec-15
Jul-15
Feb-15
Sep-14
Apr-14
20%
Nov-13
-3.0
Jun-13
21%
Jan-13
-2.0
US Inventory / Supply
Source: OPEC, EIA, Al Rajhi Capital. *We do not look at absolute amount of commercial inventories but as % of US production. For all purposes, the data of demand and supply is inclusive of crude and other condensates.
Disclosures Please refer to the important disclosures at the back of this report.
7
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Oil Demand Figure 16 Supply demand data (mmbpd) IEA 1Q15
2Q15
3Q15
3Q16
4Q16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17
Demand
93.8
94.4
96.0
95.7
95.4
95.9
97.1
97.9
95.8
97.6
97.8
96.6
97.9
99.0
98.4
98.5
Supply
95.3
96.4
97.2
97.4
96.7
96.0
97.0
98.3
96.4
97.1
96.4
96.1
97.0
97.7
98.4
97.7
1.5
2.0
1.2
1.7
1.3
0.1
(0.1)
0.4
0.6
(0.6)
(1.3)
(0.5)
(1.0)
(1.3)
0.0
(0.8)
4Q5
1Q16
2Q6
Gap
4Q5
1Q16
2Q6
Jul-17 Aug-17
Source: IEA OMR OPEC 1Q15
2Q15
3Q15
3Q16
4Q16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17
Demand
91.9
92.0
93.9
94.0
94.1
94.0
95.9
96.1
94.5
96.3
96.4
94.7
96.0
97.1
97.2
97.3
Supply
94.2
94.9
95.5
95.9
96.0
94.7
95.6
97.3
95.8
95.9
95.82
95.81
95.74
96.59
97.16
96.75
2.3
2.9
1.6
1.9
1.9
0.7
(0.3)
1.2
1.3
(0.4)
(0.6)
1.1
(0.3)
(0.5)
0.0
(0.5)
4Q5
1Q16
2Q6
Gap
Jul-17 Aug-17
Source: OPEC OMR EIA 1Q15
2Q15
3Q15
3Q16
4Q16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17
Demand
94.2
94.7
96.2
95.5
95.5
96.1
97.6
97.4
95.9
97.7
97.9
96.8
98.2
99.2
98.9
99.0
Supply
95.6
96.6
97.5
97.7
96.8
96.5
97.1
98.3
96.8
97.4
96.8
97.2
97.8
98.3
99.0
98.6
1.4
1.9
1.3
2.1
1.3
0.4
(0.5)
0.9
0.9
(0.4)
(1.0)
0.4
(0.3)
(0.9)
0.2
(0.3)
Gap
Jul-17 Aug-17
Source: EIA STEO Source: IEA, OPEC, EIA, Al Rajhi Capital
Figure 17 World oil demand, supply* and US inventory trend** 100.0
1,400
99.0 1,300
98.0
1,200
96.0 95.0
1,100
94.0
MMbbls
MMbbl/d
97.0
1,000
93.0
92.0
900
91.0
Total Supply
Total demand
Aug-17
May-17
Feb-17
Nov-16
Aug-16
May-16
Feb-16
Nov-15
Aug-15
May-15
Feb-15
Nov-14
800 Aug-14
90.0
U.S. oil inventories (RHS)
Source: EIA, Al Rajhi Capital. * inclusive of crude and other condensates. ** Total US commercial inventory
Disclosures Please refer to the important disclosures at the back of this report.
8
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Figure 18 Healthy improvement in PMI data
Figure 109 Seasonal nature of oil consumption globally* 100.0
56
98.0
54
96.0
MMbbl/d
58
52
94.0
50 92.0
48 90.0
Jul-17
Sep-17
May-17
Jan-17
Mar-17
Nov-16
Jul-16
Sep-16
May-16
Jan-16
Mar-16
Nov-15
Jul-15
Sep-15
May-15
Jan-15
Mar-15
Nov-14
Sep-14
46 88.0 Jan
Feb
Mar
2014
JPM Global Mf g. PMI
Apr 2015
May
Jun
Jul
2016
Aug
Sep
Oct
2017
Nov
Dec
2017E
US ISM Manuf acturing PMI
China Manuf acturing PMI
Source: Bloomberg, Al Rajhi Capital
Source: EIA, Al Rajhi Capital. * Inclusive of crude and other condensates. 2017e as per EIA forecast
Figure 20 Quarterly Global vehicle sales by regions
Figure 111 Regional contribution to global vehicles sales in 2Q17 1%
20
7.0%
18
6.0%
16
5.0%
14
4.0%
12
4%
23%
3.0%
10
2.0%
8
48%
1.0%
6 4
0.0%
2
-1.0%
Asia Pacif ic North America
Af rica & Mid East
Q2 2017
Q1 2017
Q4 2016
Q3 2016
Q2 2016
Q1 2016
Q4 2015
Q3 2015
Q2 2015
-2.0%
Q1 2015
-
24%
Europe Latin America
Global Vehicle Sales growth (ttm) (y-o-y)
Source: Auto Associations, Governments, Bloomberg, Al Rajhi Capital
Disclosures Please refer to the important disclosures at the back of this report.
Asia Pacif ic
Europe
Latin America
Af rica & Mid East
North America
Source: Auto Associations, Governments, Bloomberg, Al Rajhi Capital
9
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
APPENDIX Methodology of calculation of “cash required”. “Cash required” per barrel to start generating positive FCF generally varies from formation to formation, from well to well as well as from producer to producer due to different well economics, drilling techniques and depth of the formation. In simple terms, the “cash required” level is the function of drilling and completion (D&C) well cost and the amount that can be ultimately recovered from a single well. Since the amount of oil produced from the well varies significantly depending on its drilling technology, geology and well depth, we generally see different “cash required” prices within the same shale oil play. While we look at a different approach to calculate the required cash per barrel level for major US shale producers, we derive our cash required level for non-conventional US producers based on a cash basis. We have analyzed the “cash required” (based on operating profit + depreciation – interest expense – tax expense – core capex including only drilling and completion capex but excluding any acquisition capex) spent by these producers under different oil price regimes and derived the minimum required cash per barrel to cover their core spending based on available historical data.
Disclosures Please refer to the important disclosures at the back of this report.
10
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
IMPORTANT DISCLOSURES FOR U.S. PERSONS This research report was prepared by Al Rajhi Capital (Al Rajhi), a company authorized to engage in securities activities in Saudi Arabia. Al Rajhi is not a registered broker-dealer in the United States and, therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence of research analysts. This research report is provided for distribution to “major U.S. institutional investors” in reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). Any U.S. recipient of this research report wishing to effect any transaction to buy or sell securities or related financial instruments based on the information provided in this research report should do so only through Rosenblatt Securities Inc, 40 Wall Street 59th Floor, New York NY 10005, a registered broker dealer in the United States. Under no circumstances should any recipient of this research report effect any transaction to buy or sell securities or related financial instruments through Al Rajhi. Rosenblatt Securities Inc. accepts responsibility for the contents of this research report, subject to the terms set out below, to the extent that it is delivered to a U.S. person other than a major U.S. institutional investor. The analyst whose name appears in this research report is not registered or qualified as a research analyst with the Financial Industry Regulatory Authority (“FINRA”) and may not be an associated person of Rosenblatt Securities Inc. and, therefore, may not be subject to applicable restrictions under FINRA Rules on communications with a subject company, public appearances and trading securities held by a research analyst account.
Ownership and Material Conflicts of Interest Rosenblatt Securities Inc. or its affiliates does not ‘beneficially own,’ as determined in accordance with Section 13(d) of the Exchange Act, 1% or more of any of the equity securities mentioned in the report. Rosenblatt Securities Inc, its affiliates and/or their respective officers, directors or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein. Rosenblatt Securities Inc. is not aware of any material conflict of interest as of the date of this publication.
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Disclosures Please refer to the important disclosures at the back of this report.
11
Saudi All Industries Sector All Industries –All Sectors 25 October 2017
Disclaimer and additional disclosures for Equity Research Disclaimer This research document has been prepared by Al Rajhi Capital Company (“Al Rajhi Capital”) of Riyadh, Saudi Arabia. It has been prepared for the general use of Al Rajhi Capital’s clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Al Rajhi Capital. Receipt and review of this research document constitute your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this document prior to public disclosure of such information by Al Rajhi Capital. The information contained was obtained from various public sources believed to be reliable but we do not guarantee its accuracy. Al Rajhi Capital makes no representations or warranties (express or implied) regarding the data and information provided and Al Rajhi Capital does not represent that the information content of this document is complete, or free from any error, not misleading, or fit for any particular purpose. This research document provides general information only. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other investment products related to such securities or investments. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. Investors should seek financial, legal or tax advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this document and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities or other investments, if any, may fluctuate and that the price or value of such securities and investments may rise or fall. Fluctuations in exchange rates could have adverse effects on the value of or price of, or income derived from, certain investments. Accordingly, investors may receive back less than originally invested. Al Rajhi Capital or its officers or one or more of its affiliates (including research analysts) may have a financial interest in securities of the issuer(s) or related investments, including long or short positions in securities, warrants, futures, options, derivatives, or other financial instruments. Al Rajhi Capital or its affiliates may from time to time perform investment banking or other services for, solicit investment banking or other business from, any company mentioned in this research document. Al Rajhi Capital, together with its affiliates and employees, shall not be liable for any direct, indirect or consequential loss or damages that may arise, directly or indirectly, from any use of the information contained in this research document. This research document and any recommendations contained are subject to change without prior notice. Al Rajhi Capital assumes no responsibility to update the information in this research document. Neither the whole nor any part of this research document may be altered, duplicated, transmitted or distributed in any form or by any means. This research document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or which would subject Al Rajhi Capital or any of its affiliates to any registration or licensing requirement within such jurisdiction.
Explanation of Al Rajhi Capital’s rating system Al Rajhi Capital uses a three-tier rating system based on absolute upside or downside potential for all stocks under its coverage except financial stocks and those few other companies not compliant with Islamic Shariah law: "Overweight": Our target price is more than 10% above the current share price, and we expect the share price to reach the target on a 12 month time horizon. "Neutral": We expect the share price to settle at a level between 10% below the current share price and 10% above the current share price on a 12 month time horizon. "Underweight": Our target price is more than 10% below the current share price, and we expect the share price to reach the target on a 12 month time horizon. "Target price": We estimate target value per share for every stock we cover. This is normally based on widely accepted methods appropriate to the stock or sector under consideration, e.g. DCF (discounted cash flow) or SoTP (sum of the parts) analysis. Please note that the achievement of any price target may be impeded by general market and economic trends and other external factors, or if a company’s profits or operating performance exceed or fall short of our expectations.
Contact us Mazen AlSudairi Head of Research Tel : +966 1 211 9449 Email: [email protected] Al Rajhi Capital Research Department Head Office, King Fahad Road P.O. Box 5561, Riyadh 11432 Kingdom of Saudi Arabia Email: [email protected] Al Rajhi Capital is licensed by the Saudi Arabian Capital Market Authority, License No. 07068/37.
Disclosures Please refer to the important disclosures at the back of this report.
12
