Make it Rain - E&Ps Shower Cash on Shareholders as Cash Flows Rise with Soaring Oil and Gas Prices

Just two years ago, the onset of the pandemic slashed the share prices of many oil and gas producers and the idea of parking cash in a U.S. E&P seemed to make as much sense as leaving your Porsche on a midtown street with the keys in it and the motor running. But times — and commodity prices — have changed, and hydrocarbon producers have transformed themselves into cash-flow-generating machines that attract the sagest investors. Want proof? Warren Buffett’s Berkshire Hathaway recently purchased another 10.4 million shares of Occidental Petroleum (Oxy) for over $500 million, bringing its stake in the company to a substantial 16.4%. In today's RBN blog, we detail how the major U.S. E&Ps are allocating their cash flow to keep investors happy.

What a difference two years makes! In our July 2020 blog Stayin’ Alive, we discussed Oxy’s chances of recovering from the massive $36.5 billion debt it had accumulated in its ill-timed $58 billion acquisition of Anadarko Petroleum just before oil prices started to plummet in mid-2019. With its investment rating reduced from investment grade to junk, the company slashed its quarterly dividend from $0.79/share to a token $0.01, cut capital spending, and launched a major divestiture program. But soaring commodity prices have subsequently bailed out Oxy and the industry. Embracing fiscal discipline and eschewing production growth in favor of cash generation, E&Ps are transforming into significant yield vehicles — a turnaround that's led to a fivefold increase in the S&P E&P stock index. Producers who survived the pandemic with strong balance sheets, such as Pioneer Natural Resources, Diamondback Energy, Devon Energy, and EOG Resources, are already providing 10%-plus annual returns through a combination of regular and variable dividends and share repurchases. Others, like Oxy, have channeled growing cash flows to meet debt-reduction targets as they transition to significant shareholder returns.

Buffett, the 91-year-old Sage of Omaha, became involved with Oxy in mid-2019 when he committed $10 billion to help finance the Anadarko purchase in exchange for a hefty package of preferred stock and high-interest-rate debt that virtually insured his repayment no matter what Oxy’s fate. But it has been Oxy’s performance since mid-2020 that has triggered the substantial additional investment by Berkshire Hathaway. Oxy has repaid more than $11 billion in debt, including $3.3 billion in the first quarter of 2022.  With a reinvestment rate of just 26% of CFOA (cash flow from operating activities), Oxy has built a $1.9 billion cash balance that allowed it to increase its quarterly dividend from $0.01 to $0.13 and authorize a $3 billion share-repurchase program. With its massive cash flow, the company is on target to meet its short-term goal of reducing debt by $5 billion to $20 billion by year-end and has in sight a further debt reduction into the “high teens” that would mark its return to investment-grade status. Industry analysts have speculated that this milestone could prompt an offer for the entire company by Buffett’s Berkshire.