The growth-at-all-costs model for shale drillers has succeeded in ramping up U.S. oil production, but it hasn’t necessarily led to impressive financials. A group of activist investors are hoping to upend this arrangement by breaking the link between the pace of drilling and CEO pay.
Reuters reports that some activists investors are pushing for some fundamental changes to executive compensation, which they argue could make shale drilling much more profitable.
For years, shale executives have enjoyed huge paydays for increasing their companies’ oil production – the more oil produced, the more the CEO earns through pay and bonuses. Wall Street has showered money on companies that post impressive growth numbers, and higher share prices mean more executive pay.
Much of this was premised on the fact that enormous profits would eventually arrive. But to date that hasn’t been the case, and shareholders are wising up to the fact that growth-at-all-costs is probably not the best strategy. Growth for growth’s sake isn’t the same as pursuing profit; shareholders do not benefit if higher oil output doesn’t translate into a more financially sound company. In fact, many shale E&Ps lever up and issue more equity in order to fund growth, with questionable returns on that spent money. Related: Expert Analysis: Oil Prices Have Risen Too Far Too Fast
Reuters reports that the top 10 largest shale companies—including Devon Energy and Apache Corp.—paid their CEOS a combined $2.2 billion over the past decade, but shareholders have only taken in returns of 1.7 percent. Larger integrated oil companies have paid their executives less ($600 million) and earned shareholders a 3.5 percent return.
“Management teams have been rewarded far too long for destroying value,” Todd Heltman of wealth manager Neuberger Berman, the seventh-largest investor in shale producer Cabot Oil & Gas Corp (COG.N), told Reuters. “Now, there’s a paradigm shift happening.”
Reuters cites Cabot as an outlier, a company that has policies in place to incentivize shareholder returns, not simply growth. These policies include executive compensation that takes into account cost controls, as well as allowing shares for executives to be vested after three years rather than immediately, forcing management to focus on long-term goals rather than short-term gratification. The result has been a sharp improvement in the company’s share price, outpacing its competitors.
In fact, a few other shale companies that have emphasized shareholder returns have also performed better than the rest of the pack. EOG Resources’ share price is up 96 percent since 2012, tracking the broader S&P 500 pretty closely. Range Resources, on the other hand, only recently implemented new incentives to get away from the growth-at-all-costs compensation style—its share price is down nearly 70 percent since 2012, according to a Reuters analysis.
With years of performances to look back on, some analysts and investors see the huge disparity in stock prices as proof that the rest of the industry needs to follow suit. “We believe the industry is on the cusp of a gradual, long overdue shift to returns-focused investing,” Tim Rezvan, an oil industry analyst with Mizuho Securities, said in a Reuters interview.
While it remains to be seen if these changes can be implemented, they would have far-reaching consequences for the shale sector on the whole, and even more broadly, on international oil markets. Related: This OPEC Member Just Saw A Major Jump In Oil Revenue
U.S. shale is responsible for the addition of more than 4 million barrels per day of new supply since 2010, and production has roared back after dipping last year from low prices. The shale industry is spending billions, enriching executives, but so many companies are not offering meaningful returns on investment.
If investors succeed in changing the payment structure, more money would go to shareholders and less into the oil patch. Extra dollars would be paid out in the form of dividends rather than funding new shale wells. The end result could be higher share prices and better return on capital, but that could also translate into much more modest oil production.
Ultimately, that could mean lower shale output than would otherwise be the case, and perhaps higher oil prices. It won’t be surprising if OPEC is a big cheerleader for these reforms on executive compensation in the shale industry.
By Nick Cunningham for Oilprice.com
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