Wind of Change, Part 2 - Oil-Weighted Exploration and Production Companies Are Flush at $60 Oil

Despite widespread predictions that the oil and gas exploration and production sector would drown in an ocean of red ink after the crude oil price crash that started a little over three years ago, E&P companies finally returned to profitability in 2017. Better yet, with oil prices exceeding $60/bbl, margins are expected to increase in 2018, giving the 44 major E&Ps we track $24.5 billion in incremental cash flow. It’s no surprise that the 17 companies in our Oil-Weighted Peer Group are the prime beneficiaries of the higher crude price, garnering $13.6 billion, or 55%, of the incremental cash flow. Today, we continue our review of how rebounding oil prices are affecting E&P cash flow, this time zeroing in on oil-focused producers.

The severe plunge in oil prices in late 2014 and 2015 at first appeared to be a crippling blow to U.S. E&Ps addicted to wild spending fueled by $100/bbl oil prices. But most of the upstream industry weathered the crisis remarkably well through new strategies that we outlined in “Piranha!,” our market study of 43 representative E&Ps. These included the “high-grading” of portfolios, impressive capital discipline and an intense focus on operational efficiencies. After slashing capital expenditures by 70% — from $46 billion in 2014 to $15 billion in 2016 — and reducing drilling and operating expenses by an average 50%, the oil-weighted producers we track emerged financially stable. As we outlined in Jump, growth resumed in 2017, as our universe of E&Ps boosted capex by 43% to $56 billion, a level still less than half of 2014 spending. The focus of that spending shifted to premium unconventional plays, with two-thirds allocated to the Permian, Eagle Ford, SCOOP/STACK, Bakken, and Marcellus/Utica. Even at $50/bbl crude oil prices, the industry returned to profitability in the first quarter of 2017. Despite a mid-year dip in oil prices that dampened production from first-quarter 2017 levels, most E&Ps didn’t throttle back on their capital investment budgets, expecting a recovery. By year’s end, prices were up to about $60/bbl, validating their strategy, and the E&Ps we track ended 2017 narrowly in the black.

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In Part 1 of this series on E&Ps’ 2018 cash flow allocation, we detailed the new profitability of our total E&P universe — now 44 companies after losing Rice Energy and adding Ultra Petroleum and Gulfport Energy — and their overall 2018 cash flow and spending plans. As we said then, instead of investing all of their cash flow into oil and gas producing assets, the E&Ps in our study group are curbing capital spending and instead dedicating funds to reward shareholders. We pegged incremental capital spending in 2018 at $2.3 billion, leaving over $22 billion in incremental free cash flow. We counted nearly $7 billion in new share repurchases, as well as another $710 million in newly announced dividend gains. Part of the remaining free cash flow will be used to reduce some of the $184 billion in debt that remained outstanding at the end of 2017.

Today, we dive deeper into the Oil-Weighted E&P Peer Group. Perhaps the most surprising news is that the 17 oil-weighted E&Ps — benefiting from significantly higher oil prices — are continuing to exhibit the remarkable new financial discipline that drove their unexpectedly strong recovery from the price crash. Altogether, these oil producers are only allocating an additional $2.1 billion — less than one-sixth of the $13.6 billion in additional cash flow — to increased capital expenditures, resulting in a modest 9% boost in 2018 capex. The remaining $11.5 billion in free cash flow will be reserved for strengthening balance sheets and rewarding shareholders through higher dividends and share buybacks. That’s noteworthy for an energy sector renowned for its financial profligacy in the emergence from down cycles over the last three decades.

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