Rightsizing for a lower oil price

The need to reduce costs and improve efficiency within the Oil & Gas industry was clear during the 3Q results with oil prices languishing below $50/bl and sector earnings down 54% y/y

Although cash flow was supported by the combination of a strong downstream environment and working capital release, that support is set to lessen over 4Q and we therefore see greater reliance on cost savings for performance. The message from companies was consistent with one of a lower for longer environment with most management teams citing a cash breakeven target of $60/bl. Even though this is unlikely to be achieved until 2017, there was evidence that progress is being made with sector capex down 21% y/y and 2016 budgets further reduced by BP and Chevron. This is consistent with our US Oil Services team who think that global upstream spending could now be down by as much as 20% in 2016 with estimates to take another leg down. For the Big Oils however, we see the move as encouraging and one that will continue to support the dividend and leave the sector better positioned for an eventual oil price recovery. We remain positive on the European Integrated Oils.

US Oil Services estimates to take another leg down: Despite improving oil fundamentals, SLB pushed out its recovery timeline to 2017, which was confirmed with several majors cutting 2016 spending. Even if oil prices recovered over the next several quarters, it won’t help services much as balance sheets are prioritized over spending. Middle East activity is still holding up, but a new round of pricing concessions is unwelcome news as investors recall that service companies never got back the pricing conceded in 2010.

Progress on capex: Sector capex over 3Q of $40.6bn was down 21% y/y and is the lowest we have recorded since 1Q 2011.The budgets for 2015 are down 16% y/y and we currently forecast 2016 group capex down a further 6%.