The sun was shining and wind filled the sails of the 44 major U.S. exploration and production (E&P) companies we track in the third quarter of 2018 as they collectively reported a 35% increase in pre-tax operating income over the previous quarter. It’s been an up-and-down year. Increased efficiency and rising output from the transformation to large-scale, manufacturing-style exploitation of premier resource plays moved the E&P sector solidly into the black in early 2018 after three years of losses. But profits stagnated in the second quarter on a decline in revenues as widening differentials, primarily in the Permian Basin, negated the impact of higher NYMEX prices. Today, we explain how producers overcame the headwinds to resume profit growth in the third quarter, but warn that future returns for certain E&Ps could be jeopardized by the sudden plunge in oil prices.
How We Got Here
As we detailed in our Better blog series, after $160 billion in pre-tax operating losses in 2015-16, oil and gas producers implemented a strategic and operational transformation to pull themselves out of the red in 2017 and put themselves in position to benefit from rising commodity prices in 2018. And, as we described in the I Feel Good series, our universe of 44 E&P companies cashed in on higher realizations in the first quarter, reporting the highest pre-tax net operating profits and cash flows since 2014. But second quarter 2018 profits were flat at $10.7 billion, and revenues fell 2% to $34.39 per barrel of oil equivalent (boe) compared with the first quarter despite NYMEX and Cushing oil prices increasing by about $5/bbl (see our Big Machine series). A major driver was a blowout in the Midland, TX, to Cushing, OK, oil price basis differential –– from $0.40/bbl in the first quarter, on average, to about $8/bbl in the second quarter because of pipeline takeaway constraints. This dampened the revenues of the two-thirds of the companies in our Oil-Weighted and Diversified peer group that produce from the Permian Basin and resulted in a cautious outlook for the remainder of the year.
The RBN NATGAS Haynesville is a weekly natural gas fundamentals analysis focused on supply, flow, and LNG-driven demand dynamics within the Haynesville basin.
Third-Quarter Results
However, as shown in Figure 1, E&P pre-tax operating earnings surged 35% to $14.7 billion in the third quarter (light-blue bar in graph to left) over the previous quarter and a seven-fold increase over a year earlier on rising revenues and lower costs in nearly every expense category. All but one of the 44 E&Ps we track were profitable in the July-through-September period, with only EQT Resources posting a loss. The primary impetus for the higher income in the third quarter was stronger realized prices, which were 7% higher than the previous quarter ($36.65/boe vs. $34.23/boe) and 28% higher than the year-ago period ($28.66/boe) –– despite still-wide Permian differentials. Also, after rising in the second quarter, total costs ($23.65/boe) were 2% lower quarter over quarter and nearly 12% below a year ago. Compared with the second quarter of 2018, lifting costs were up $0.14/boe because of an $0.18 increase in price-sensitive production taxes, while impairment charges were down nearly $1/boe. Total costs were down mainly because of the plunge in impairment charges. Depreciation, depletion and amortization (DD&A) expenses and exploration charges were also lower. Finally, the gain in production costs was solely due to the rise in production taxes.
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About the song
“Here Comes the Rain Again” was written by Annie Lennox and Dave Stewart. It appears as the first song on side one of the Eurythmics’ third studio album, Touch. Released as a single in January 1984, it went to #4 on the Billboard Hot 100 Singles chart. Personnel on the record were: Annie Lennox (vocals, keyboards), Dave Stewart (guitar, keyboards), the British Philharmonic Orchestra, and Michael Kamen (string arranger and conductor).
Touch was recorded in 1983 at The Church studio in London and produced by Dave Stewart. Released in November 1983, it went to #7 on the Billboard 200 Albums chart and has been certified Platinum by the Recording Industry Association of America. Three singles were released from the LP.
Eurythmics was a British pop duo formed in London in 1980 by Annie Lennox and Dave Stewart. Both had previously been in the British punk band, The Catch, and the British pop band, The Tourists. They achieved international success with the Eurythmics’ single, “Sweet Dreams (Are Made of This),” which went to #1 on the Billboard Hot 100 Singles chart and was certified Gold by the RIAA in 1983. They released eight studio albums, a soundtrack album, a live album, two compilation albums, an EP, and 33 singles. They sold more than 75 million records worldwide. They have won a Brit Award, a Grammy Award, an MTV Video Music Award, and were inducted into the Songwriters Hall of Fame in 2020 and the Rock and Roll Hall of Fame in 2022. The group unofficially broke up in 1990 but has had a few reunions since then. Lennox has a successful solo career, and Dave Stewart is a highly regarded record producer. In March, Lennox played her first live performance in over six years at the Royal Albert Hall in London. Stewart will be embarking on a European summer tour with Eurythmics, featuring Vanessa Amorosi on vocals, beginning in July.
Comments
What you call cash flow are you referring to free cash flow? Concho had negative FCF (-88) as several of the Permian companies. Parsley had -156MM; Cimarex -66MM, Diamondback -173 MM (TTM -673MM), Devon positive 236MM but reduced production and had -467MM (TTM). Yes net results are positive, but it seems that production growth and FCF are incompatible even at the previous prices. With some rare exceptions like EOG. Am I missing something here?
No, the cash flow we are measuing is pre-tax operating cash flow. We are not accounting for capex, nor any corporate charges (ie; interest expense, G&A, etc. ). We're trying to get a feel for field level profitability and cash flow.
We are working on an analysis of capex over the next decade and will touch on FCF and the allocation of capital by E&P companies. That analysis will be available in 1Q/19.