Rallying oil prices are testing once again the U.S. shale patch's resolve to spend within their means and prioritize profitability over production growth.
U.S oil prices above $55 a barrel are also testing the patience of investors with American oil producers, and investor hopes that this time around shale firms will keep, for a change, their promises to stay disciplined in spending for drilling. The higher the price of oil, the greater the temptation to plow more cash into new wells.
The fact that U.S. oil companies are a motley bunch of large publicly traded corporations and small privately held firms is not making the industry's pitch to regain investor confidence easier, either. The bigger listed firms continue to vow discipline and sustainable production growth, while some private companies are set to continue outspending cash flows to boost production at these higher oil prices.
Considering that U.S. producers are not a coordinated bunch of market players like OPEC, investors are only cautiously optimistic that the 2020 downturn may have resulted in a lasting strategic reset of priorities for the shale patch. Investors want to believe that this time profitability, not production, will inform spending decisions at most companies.
The industry, for its part, wants to convince the market that it has finally learned its lesson and has a way to win investors over again.
Investors and the market haven't rewarded U.S. shale for its record production growth in recent years, and they will punish the stocks again if they do not 'see the money.'
Disillusioned Investors Punish Oil Stocks
At the end of last year, the energy sector represented just 2.28 percent of the S&P 500 index-a new historic low, especially if compared to 12.03 percent of the index in 2010 and 4.35 percent as of the end of 2019. The rise of information technology and financials over the past decade has something to do with this, but so do disappointed investors who have been waiting for years for U.S. shale firms to 'show them the money,' and prove they can turn in profits and return investments.
Related: Shell's Profits Plunge 87% In 2020
Over the past three months, the energy sector has been on a tear, helped by the oil price rally on the back of vaccine rollouts and the prospect of a tighter market courtesy of the OPEC+ production cuts and expectations of economic and oil demand growth this year.
Yet, investors wait to see the money from U.S. shale and are cautiously choosing to believe, for now, in the promised capital discipline.
Some listed companies now look very attractive after the energy stocks plunged last year, but cautiousness prevails about spending-within-means pledges.
"I see attractive fundamentals that I haven't seen for 20 years," Aaron DeCoste, an equity analyst at institutional investor Boston Partners, told Financial Times' Derek Brower and Myles McCormick.
Yet, the analyst is still cautious about the shale patch's renewed commitment to rein in spending.
Large Firms Continue To Vow Discipline
The pandemic-driven collapse in oil demand and prices accelerated the shift to capital discipline in the biggest U.S. shale basin, the Permian.
Last year, for the first time ever, Permian operators as a whole did not outspend their upstream cash from operations, Rystad Energy has estimated. In 2020, the reinvestment rate - that is the percentage of upstream cash from operations going into capital expenditures - dropped to below 100 percent for the first time ever, to 84 percent, compared to 121 percent in 2019, according to Rystad Energy.
This year, big listed firms such as Occidental, Pioneer Natural Resources, and Devon Energy continue to promise discipline in spending and no reckless races to record production. Pioneer and Devon Energy are also working to distribute variable dividends on top of the base dividend to fulfill promises for increased shareholder returns.
"This is a sector that is trying to regain favor with investors. And it hasn't earned its cost of capital. And the way out of that isn't by investing more capital," Chevron's chief financial officer Pierre Breber said on the U.S. supermajor's Q4 earnings call last week.
Consolidation Could Help Restore Wall Street's Confidence In Shale
It was Chevron that first announced a major acquisition since the pandemic started, effectively launching a wave of a long-awaited consolidation in the shale patch.
Investors seem to like the increased scale of operations, lower costs, and quality assets in the deals made at the end of last year.
Industry executives and analysts believe that the consolidation is not over, and it will likely leave a financially healthier bunch of operators with lower costs and increased synergies and efficiencies.
"Wall Street appears supportive of E&P deals, but with very specific expectations on deal structure and the quality of the merger target," Andrew Dittmar, M&A Analyst at oil and gas data analytics company Enverus, said last month.
Most industry executives said in the latest Dallas Fed Energy Survey in December that they expect the number of publicly listed independent E&P firms in the U.S. to shrink to fewer than 48 by the end of 2022 from around 60 currently.
"I don't think M&A is done in this business. I think you got to continue to drive down cost of supply, you want the best resource in the business, and you got to be the most sustainable company from an ESG perspective," ConocoPhillips's CEO Ryan Lance said on the Q4 earnings call this week.
Capital discipline, higher shareholder returns, and lower costs could be the incentives that could attract investors back to U.S. shale. But investors will want to see the money first.
By Tsvetana Paraskova for Oilprice.com
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Comments
Since its inception, the US shale oil industry’s work ethics was characterized by greed and irresponsible production aimed at undermining OPEC+ efforts to prop oil prices and also gain market share at its expense. But that approach has led to increasing numbers of bankruptcies, mounting debts estimated at hundreds of billions of dollars and a loss of investors’ confidence culminating in a virtual collapse of the US shale oil industry during the COVID-19 pandemic. What made that collapse severer is encouragement by former President Trump to the shale industry to put geopolitics ahead of economics in the form of reckless production to achieve US energy dominance or oil self-sufficiency. All this ended in a decisive victory for OPEC+ over US shale oil.
WTI prices above $55 a barrel will test the shale oil drillers’ resolve to produce responsibly, boost returns to shareholders and not sink all the cash into drilling. Investors may not give the industry another chance.
The fact that shale oil drillers are a motley bunch of large publicly traded corporations and small privately held firms shouldn’t detract from efforts to regain investors’ confidence. After all, OPEC+ members are also a motely bunch of countries but they have managed to put aside their considerable differences and interests and work together to bolster the oil prices.
Despite the above, I doubt shale oil drillers would have learnt a lesson from their ordeal. A case in point is the US Energy Information Administration saying yesterday that it expects US oil production to surpass in 2023 the previous annual average of 12.25 million barrels a day (mbd) achieved in 2019.
The crucial situation facing the shale oil industry is that its fate is now in the hands of OPEC+. Were OPEC+ to end its production cuts and go for market share, prices will fall and this will immediately and very adversely impact on shale oil production.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London