Integrated Oil:4Q17Outlook:Staying the Course

After a dismal last few years, the strong start for E&Ps so far in 2018 feelsborderline disorienting (DB coverage +7.5% YTD vs. S&P 500 +4.8%). Andalthough we remain wary the current price of crude, and expect a pullback atsome point, we remain constructive on the group and expect 4Q earnings to be alargely positive event. Budgets are likely to suggest a reasonable commitment tocapital discipline, at least for now (ie. within cash flow at well below the currentprice), well performance remains robust, and positive revisions are likely to remaina tailwind (DBe FY18 +3% vs. Street). A slight offset: service inflation is likelyrunning ahead of Street expectations, while lag from development-focused shiftcould see volume growth lumpy and/or back half weighted. For 2018, we preferEOG, DVN and NBL. Into 4Q: PXD, EOG, and MRO.

    With front-month and near-term benchmark prices rising above $60/$65/bbl (WTI/Brent), the capital discipline mantra will be put to the test during budget season asincremental cash flow priority will take center stage. Based on our conversations,we expect most of the large-caps to largely "hold the line" on capex (for now) andstick to budgets based on $50-$55/bbl crude. We estimate an incremental ~$5bnof cash flow at the updated DB price deck ($56/$62 WTI/Brent FY18), and $4 Bnof FCF at the current strip (or $65/$60) and while we see some with the ability/interest to flex capital spending higher (MRO/EOG/APA/XEC/CXO), the majorityof our coverage pointed toward incremental cash flows being put toward thebalance sheet/outspend, as the back end of the oil curve remains in the mid $50swith the prospect of OPEC barrels coming back to the market in 2019, and a USonshore production profile biased to the upside in terms of 2018 growth, withestimates now re-approaching 900 mb/d. Given strength in the 2018/19 strip, welook for updates on hedging (sector 16%/3% hedged in 2018/19 at Q317) andits potential impact on activity levels. We see those with higher Brent leverage(OXY/COP/APA/MUR) as those to incrementally benefit from a widening Brent/WTI differential, while those with WCS leverage (DVN) will likely see short-termheadwinds.