US upstream Q3 earnings likely to focus on 2023 capex, E&P production levels

Third-quarter 2022 earnings for US oil and gas producers are likely to focus on E&Ps' outlook for their capital budgets for both 2022 and 2023, and any change in drilling programs and production levels for either year, especially in light of the recent OPEC+ agreement to cut production from current output levels.

Announcement of the 2 million b/d cuts, which provided a near-term price prop amid a backdrop of cloudiness that also includes inflation, the Russia-Ukraine war and China's coronavirus policy, also boosted sagging oil prices that had begun to dip below $80/b and lifted them into the high $80s to low $90s/b.

But even at higher oil prices which are well above breakevens of around $42s/b for major US shale plays, undoubtedly some uncertainty remain over how E&P operators will set their budgets and production targets. And that will be the main fodder for Q3 E&P calls that are set to roll out in the next few weeks, analysts say.

"Following the OPEC+ decision to cut production and the resulting improvement in oil price sentiment, we expect the key area of focus for investors heading into third-quarter earnings would be on the 2023 outlook including production and capex guidance from producers," Goldman Sachs analyst Neil Mehta said in an Oct. 7 investor note.

While operators are unlikely to provide clear-cut budget plans for 2023, upstream operators' capex next year should increase – but from continued inflationary pressures rather than activity boosts, Sami Yahya, senior energy analyst-supply and production analyst for S&P Global Commodity Insights, said.

Yahya noted the annual capex increase in 2022 is "a little more than 30%," which was mostly driven by cost inflation around 15% to 20%.

Capex to rise further in 2023

"While we do expect capex to further increase in 2023, it will not be as much as this year since many operators stated they expect cost inflation next year to increase less than this year," he said, adding cost inflation in 2023 will likely be around 10% to 15%.

"We also know that operators will likely target similar flat to single-digit production growth rates next year, meaning most capex increase in 2023 will be driven by cost increase, not production growth."

In fact, much of the domestic upstream sector may have already settled on a lower 2023 capex and production profile, given what Evercore ISI analyst Stephen Richardson called "both top-line crude volatility and an upstream industry less hedged in 2023," as well as inflationary trends facing incremental activity.

"Third-quarter reporting season just got more interesting," Richardson said in an Oct. 10 investor note. "Capex push-pull will be on full display."

"There is an interesting inconsistency in the energy outlook where market participants (particularly OPEC) are attempting to encourage more upstream investment to support the supply outlook on a multi-year view," he said. "So we expect a healthy push on the potential for a 'call' on shale as the market contemplates 2023 – particularly if the expected growth wedge from the US onshore in fourth-quarter 2022 doesn't materialize."

The certainty provided by market balance from OPEC's action "should bridge the market to a better fundamental outlook in 2023," he added.

Fiscal conservatism generally characterizes US oil producers when forward dynamics are uncertain.

E&Ps remain disciplined

With crude prices off their earlier-year highs over $100/b, E&Ps continue to reap abundant cash flows that allow them to fund capital programs, pay down debt and generously reward shareholders – and still grow production up to 5% (for larger-caps) to the low double-digits (smaller-caps). That has satisfied producers and stabilized the market in the years following the coronavirus pandemic which created havoc with oil prices in 2020.

The OPEC+ cuts, unveiled Oct. 5, were predicated on a weaker demand outlook. The reductions will likely amount to a little over 1 million b/d, since most OPEC countries aren't producing at quota level.

But cloudiness over demand may be a signal to US E&P companies to pull in their belts as well on activity increases, including sharp growth in rig counts, Tortoise managing director Rob Thummel said.

According to Baker Hughes data, the US land rig count had been in the 740s since mid-July save for one week when it reached 750. But on Oct. 14 it leaped to 755.

"I guess we'll see some modest growth in the rig count next year," Thummel said. "But it will be hard to make it to 800. I see the US production curve flattening out, especially now since we're getting to the end of the year for budgets – and [operators] may exhaust their budgets early."

"I think the era of cheap energy is probably over," he added. "I don't think we'll go below $50/b oil and $3/Mcf natural gas."

While E&P capexes and production targets are almost certain to be Q3 headliners, operators have expressed additional concerns in recent weeks.

Said Yahya: "In the upcoming quarterly calls, I think operators will also continue to tackle matters of labor and equipment security, balance sheet commitments, as well as emissions targets and goals. Operators will also likely address issues relating to the IRA [tax consequences of the US' recently approved Inflation Reduction Act] and the associated implications."