Wind of Change - Rebounding E&Ps Curb Capex Growth, Use Capital to Reward Shareholders

How a company or industry handles adversity is a valuable test of its mettle. But assessing long-term sustainability requires a second test: handling prosperity. Recently released 2017 results of U.S. exploration and production (E&P) companies confirm that the industry not only defied predictions of widespread bankruptcies and credit defaults after the oil price plunge in late 2014, but learned to generate profits in a $50/bbl crude oil price world. And the E&Ps’ 2018 guidance, issued as oil prices appear to have stabilized above $60/bbl, indicate that the industry is sticking with the new financial discipline that drove its recovery, a remarkable departure from the financial profligacy in the emergence from down cycles over the previous three decades. Today, we examine how 44 large U.S. E&Ps are responding to a rebounding oil sector.

Here are the numbers. After $164 billion in losses in 2015 and 2016, the 44 top U.S. E&P companies we track reported a little under $1 billion in total pre-tax operating profits last year. Of note, the group as a whole posted a small profit even though producers had maximized their write-downs last year in advance of the much lower corporate tax rates that went into effect in January 2018. Our universe of E&Ps generated $80 billion in pre-tax operating cash flow in 2017, and that is forecasted to increase by nearly $25 billion, or 31%, in 2018. But remarkably, the E&Ps we track have budgeted only a modest $2.3 billion — or 4% — increase in capital expenditures. Instead of pouring every nickel back into boosting portfolios and production, E&P companies have begun allocating capital to repurchase undervalued shares and restore previously slashed dividends, as well as continuing to repay debt to improve their balance sheets.

How We Got Here

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 despite predictions of widespread bankruptcies and credit defaults, 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. As we explained in Very Particular Places to Go, these included the “high-grading” of portfolios, impressive capital discipline and an intense focus on operational efficiencies. After slashing capital expenditures by 70% — from $132 billion in 2014 to $39 billion in 2016 — and reducing drilling and operating expenses by an average 50%, most companies emerged financially stable. As we outlined in Jump, growth resumed in 2017, as our universe of E&Ps boosted capital investment 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. Even at $50/bbl crude oil prices, the industry returned to profitability in the first quarter of 2017 after massive losses in the previous two years, as we detailed in Recovery. Despite a mid-year dip in oil prices that dampened production from first-quarter 2017 levels, we revealed in I Won’t Back Down that most E&Ps didn’t throttle back on their capital investment budgets, expecting a recovery. A nice rebound in oil prices to over $55/bbl in October 2017, above the December 2016 mark, validated their strategy, and the E&Ps we track ended last year in the black.

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