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Maintenance Costs, Debt Ding Cash Flow Plans of Big Independents, IHS Says

Chesapeake Energy Corp. and Encana Corp. have the highest maintenance capital costs and debt in their peer group, while EOG Resources Inc., Range Resources Corp., and EQT Corp. may be among those best positioned, enabling them more easily to replace forecasted production this year with cash flow, according to IHS Inc.

"Maintenance capital requirements -- or the percentage of 2015 estimated cash flow required to replace forecasted 2015 production -- are running high for some larger North American exploration and production (E&P) companies," IHS researchers said in an energy company performance analysis. The lower the maintenance capital requirement as a percentage of cash flow, the more cash a company has left to reinvest.

After replacing production for the period, E&Ps use remaining cash flow to reinvest in reserve and production growth, debt reduction, share repurchases and dividend payments.

"Our analysis of maintenance capital for the large North American E&Ps indicates that those with lower maintenance capital costs have greater spending flexibility to reduce debt, invest in growth, or make opportunistic asset acquisitions, which is important in the current depressed market," said IHS Energy's principal equity analyst Paul O'Donnell, who authored the report. "Generally speaking, the stocks of the companies that performed well by this metric have outperformed those that didn't."

Continental Resources Inc., one of the biggest Bakken Shale and Midcontinent operators, and Appalachian operators EQT, Range and Antero Resources Inc. were found to have the lowest maintenance capital requirements as a percentage of 2015 estimated cash flow.

"For the Marcellus players, these lower requirements reflect their efficient drilling success in the play, which has kept their unit finding and development costs (FDC) competitively low," the report said. The group with the lowest maintenance capital requirements is expected to generate sufficient cash to fund additional growth beyond replacing production.

Continental, EQT, Range and Antero each reported 2014 three-year weighted-average FDC of between 66 cents/Mcfe ($3.93/boe) and 74 cents/Mcfe ($4.43/boe). Continental "has the lowest maintenance capital requirement of the liquids-weighted producers at just 37%, compared with the North American peer group median of 87%," O'Donnell said.

On the opposite end of the spectrum, Chesapeake and Encana "have the highest maintenance capital requirements and the highest debt in the peer group." Chesapeake, Encana and Devon Energy Corp., another one of the biggest onshore E&Ps, "each have maintenance capital requirements greater than 100% of forecasted 2015 cash flow, meaning that, in order to grow, pay dividends or reduce debt, they will have to outspend cash flow by a significant amount," according to IHS.

"The combination of high maintenance requirements and high debt puts companies in a tough spot because their options to finance growth beyond replacing production become more limited," O'Donnell said.

Chesapeake and Encana each have turned to asset sales as a well to fund spending; Chesapeake also has cut its common dividend (see Shale DailyAug. 25July 21). Devon, which like Encana has incurred more debt to secure liquids leaseholds, initiated cost savings initiatives earlier this year (see Shale DailyMay 6).

Meanwhile, EOG, mostly an onshore oil producer, along with Range and EQT "are best positioned" with low maintenance capital requirements and low debt, according to IHS.

By comparison, large E&Ps with more global and offshore operations, including Noble Energy Inc., Anadarko Petroleum Corp., Apache Corp. and ConocoPhillips, ranked "in the middle of the pack for maintenance capital requirements." Their peer group median of 87% "leaves little capacity for cash flow to fund additional growth beyond replacing production."

"These middle-of-the-pack companies will likely be reliant on credit facilities, debt, stock issuances or asset sales to fund growth," O’Donnell said.

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