Big Machine, Part 3 - E&Ps' Second-Quarter Profit Growth Squelched by Stagnant Realizations

The U.S. exploration and production sector has reaped many benefits from its transformation to large-scale, manufacturing-style exploitation of premier resource plays, generating record oil and gas production while slashing production and reserve replacement costs by 50%. While increased efficiency and rising output have moved the industry solidly into the black after three years of losses, profit growth stalled in the second quarter 2018 despite a $5/bbl increase in oil prices to about $68/bbl. The cause is largely beyond the control of the producers: constraints on getting the increased output to markets. In certain producing regions, most notably the Permian Basin, production growth has far outpaced expansions to the infrastructure required to process and transport it. Today, we explain why these constraints are critical to assessing the outlook for industry profitability and cash flow over at least the next two to four quarters.

How We Got Here

This is the third blog in our series on how 44 representative U.S. E&Ps have been faring financially. As we explained in Part 1, the U.S. E&P sector has performed admirably so far this year compared with year-ago results, reporting $22 billion in pre-tax operating profits in the first half of 2018, over three times the $6.2 billion reported in the same period in 2017. Likewise, they’ve reported over $51 billion in operating cash flow, up from $39 billion a year ago. Although these companies are on pace to garner $30 billion in free cash flow in 2018 as a whole, our group of 44 E&Ps continued to exercise financial discipline, raising their 2018 capital spending guidance by only $3.9 billion, or 5% over their initial guidance, to $68.1 billion, which is 10% higher than their 2017 investment. In Part 2, we analyzed their capital investment and forecasted production growth by peer group and company. We revealed that the Oil-Weighted E&Ps reported the largest mid-year increase in capital spending — $2.3 billion to $28.1 billion, or 9% higher than their original 2018 guidance and 19% higher than 2017 outlays. Fifteen of the 17 companies in the group expect to increase production in 2018, with total output rising 11% to 1.37 billion barrels of oil equivalent (Bboe). The Diversified E&Ps will increase capital outlays by 10% to $29.9 billion in 2018, but the impact of major divestitures by several companies in the group will leave output flat with the previous year. The total capital spending by the Gas-Weighted E&Ps increased by 2.7% over the peer group’s previous 2018 guidance, but total capital investment will still be 7% lower than 2017. However, total production is still expected to increase 10%. In today’s blog, we do a deep dive into the industry’s bottom line by analyzing second-quarter versus first-quarter 2018 results by peer group.

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