peer group

You may not know it by the look of the S&P E&P stock index, which has been flirting with record lows in recent weeks, but exploration and production companies are continuing to defy the industry’s legendary boom-and-bust cycles by pumping out increasing volumes of crude oil and natural gas while slashing spending. Some types of E&P companies have fared better than others in this lower-price environment. How are they continuing to generate substantial production growth under sharply lower capital investment programs? Today, we update our analysis of capital expenditures and production growth based on the second-quarter results of the 43 U.S. oil-focused, gas-focused, and diversified producers we track.

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.

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.

U.S. exploration and production companies (E&Ps) are generating such substantial output growth that the International Energy Agency (IEA) estimates their increase in 2018 liquids production could equal the entire growth in global demand. Remarkably, they’re accomplishing this with half the capital investment of 2014. The driver has been a shift to a manufacturing mode that has transformed the E&P industry as dramatically as Henry Ford’s moving assembly line changed the automobile industry in 1913. Geophysical and technological innovations, such as multi-well pad drilling, have allowed the industry to double output per well bore at half the previous cost. With oil prices and margins rising, you’d think the E&P industry, which historically has invested like “there’s never too much of a good thing,” would be pouring every available dollar into drilling more and more wells. But that isn’t the case. Instead, mid-year 2018 guidance shows that producers have adopted the long-term investment strategies usually associated with integrated oil majors, plotting incremental increases in investment to methodically accelerate production growth to 2020 and beyond.

In the first half of 2018, the U.S. E&P sector continued to reap the benefits of its dramatic evolution from decades of “boom or bust” exploration to large-scale, manufacturing-style exploitation of premier resource plays. Upstream companies halved their break-evens and reserve replacement costs through technological innovation, financial discipline, and ruthless portfolio paring, which allowed them to generate record domestic oil production in 2018 on half the capital outlays expended in 2014. As a result, the 44 E&Ps we track reported $21 billion in pre-tax operating profits in the first half of 2018, up from $6.2 billion in the first six months of 2017, and over $50 billion in operating cash flow, up from $39 billion a year ago. Most notably, these companies are on pace to garner an astonishing $30 billion in free cash flow. Today, we discuss the ongoing effort by leading E&Ps to maintain financial discipline in a period of strong oil and gas prices.