US Lower 48 exploration and production companies are under pressure from investors demanding greater capital discipline, positive free cash flow, and increasing returns. The Lower 48’s independents, who traditionally pursued growth at all costs, must now rein in their impulses and focus on delivering returns to their shareholders.
“As US independents release their budgets over the course of this month, we expect to see their growth aspirations take a back seat. Cash flow neutrality is more important than ever—and this will be the key focus as companies announce their 2019 guidance,” noted Roy Martin, part of Wood Mackenzie’s corporate analysis team.
Martin said, “Investment will be adjusted down as oil price expectations have slipped. But at prices above $50/bbl [for West Texas Intermediate crude], shareholder distributions will be higher up the capital allocation pecking order than investing for growth. Organic free cash flow—if generated—will play an important role in sustaining share buyback momentum.”
With prices at $50/bbl WTI, to achieve cash flow neutrality this year, WoodMac estimates that, as a group, US independents need to cut spending by 6% relative to 2018 levels.
Martin said that at $50/bbl WTI, Hess Corp., Apache Corp., and Noble Energy Inc. are under the most pressure, “but they are focused on delivering large-scale, capital-intensive projects this year.” He said, “Many companies have already set activity levels with the aim of achieving cash flow neutrality around $50/bbl, most notably tight-oil stalwarts Pioneer, Concho, and Continental.”
He said, “The cuts required at lower prices would be substantially higher. For example, at $40/bbl WTI, the peer group would need to cut nearly $18 billion of capex—that’s roughly 38% less than in 2018—to collectively balance the books.”
Martin added, “Free cash flow generation at $60/bbl WTI is broadly in line with the $14 billion of share buybacks announced by the peer group in 2018. Buybacks and debt repayment are likely to soak up the majority of the surplus free cash flow at higher prices.”
Those companies with the strongest tight oil portfolios will find it tempting to relax capital discipline at prices higher than $50/bbl WTI, he said.
“Top-flight operators such as Pioneer, EOG, and Concho command vast tight oil positions in the Permian with NPV 15 breakevens below $40/bbl WTI. These low breakeven assets underscore the strong incentive to invest. But we expect shareholders to be favored in the distribution of surplus cash flow—moderate dividend increases for some; buyback programs for most.”
Those companies carrying higher debt and with weaker free cash flow outlooks will find lower prices more challenging. Having divested over $50 billion of assets since 2015, most of the low-hanging fruit has already been sold, highlighting the pressure for companies such as Apache and Chesapeake to dial down capital expenditures at lower prices.
“Expect fast reactions to price signals,” Martin said. “Consolidation is likely to remain a core theme—driven by a variety of strategies, including the desire to improve returns, deleveraging via equity-backed corporate acquisitions, or simply opportunistically taking advantage of valuation multiples in an unloved sector.”
