Oil and Gas Producers: Incorporating Lower Well Costs From 2024

We have refreshed our oil and gas producer valuations to incorporate the latest outlook for near-term commodity prices after a particularly volatile spell for both oil and gas futures during the recent reporting season. In addition, we have incorporated a slight reduction in well costs from 2024 across our upstream coverage, based on consistent commentary from both producers and oil service firms. The latter supplies equipment and services to the former to enable the drilling and completion of oil and gas wells. This includes oil country tubular goods, or OCTG, which are sensitive to prevailing steel prices, proppant (typically sand, for fracking), and labor. Supply and demand for these services also affects pricing. As oil services firms typically operate under contract, there is a lag between inflationary pressures and the resulting impact on upstream spending levels, when contracts are renewed at current rates. And the same holds true in reverse.

Producers mainly agree that inflation has cooled off, with several anticipating moderate price declines in the back half of 2023, and service providers are reporting that the markets for rigs, OCTG, and proppant have leveled off. The recent decline in commodity prices also supports a moderating environment for well costs, as these are historically correlated. And since the late 2022 peak, the North American rig count has declined by about 6%, signaling weakening demand for oil services in that region. Our upstream valuations now include a 5% decrease in well costs beginning in the first quarter of 2024.

Marking to market for updated near-term commodity prices and incorporating lower well costs modestly affects the fair value estimates for a handful of exploration and production firms, or E&Ps, in our coverage (APA APA, Antero AR, Coterra CTRA, Diamondback FANG, Marathon MRO, Murphy MUR, Pioneer PXD, and Range RRC). There are no valuation changes greater than 5% in either direction. The average valuation increase is 1%.