U.S. publicly traded producers appear to be embracing the “Shale 2.0” mantra of spending discipline and shareholder returns, with capital spending trending down from 2018, according to analysts.
Several financial analysts in the past few weeks have dissected the fourth quarter results and conference calls by various exploration and production (E&P) companies to determine whether capital expenditures (capex) and development will measure up to 2018 or decline.
Wells Fargo Securities LLC’s covered E&Ps, which include most of the largest onshore operators, have reduced capex, with overall spend for its group now expected to be down 11% year/year (y/y).
The 4Q2018 earnings results and updated 2019 guidance by E&Ps confirmed Rystad Energy’s expectations that most Lower 48 operators plan to moderate drilling and completion activity this year, prioritizing capex discipline over aggressive growth.
“Setting budgets under an assumption of $50-55 West Texas Intermediate (WTI) oil price, numerous producers have reported plans to cut spending levels substantially,” Rystad analysts said.
Based on 4Q2018 reporting and 2019 guidance of around 50 U.S. E&Ps, Rystad expects operators to decrease capex by around 6% from 2018.
However, as the independents have cut capex, many of the large producers and supermajors are flexing their muscles, particularly in the Permian Basin, Wells Fargo analysts noted.
Meanwhile, after a collapse in oil prices in 4Q2018 motivated a slowdown in activity by the private E&Ps, with an estimated 21% sequential reduction in completions, “a rebound in commodity prices may foreshadow a return of higher activity from these operators,” the Wells Fargo team said.
“Although our overall 2019 well completion estimate for U.S. shale is relatively unchanged at 5% fewer wells y/y, we expect the share of majors to increase from 8% in 2018 to 11% in 2019,” analysts said. “While we increase our private activity estimate, we still expect 12% fewer y/y completions, bringing down their share of U.S. completions from 35% to 31%.”
The Wells Fargo team expects a “crowding out” of private E&Ps, rather than public companies, as the majors increase their unconventional activity. ExxonMobil Corp. and Chevron Corp. recently announced they are stepping up development in their No. 1 U.S. target: the Permian.
Wells Fargo is estimating U.S. oil production will reach 12.1 million b/d, baking in changes to the basin mix and activity levels. Beyond 2019, they expect to see 1.3-1.4 million b/d per year of growth through 2023 as the majors’ activity gains momentum, which is “likely a headwind for oil prices.” For natural gas, 2019 output is estimated at 90 Bcf, but the longer term estimates increase by 5-6 Bcf.
Evercore ISI’s analyst team, which spent a couple days in Houston recently to meet with energy companies across the spectrum, said the increase in WTI oil prices should provide a lift to the local economy, if not the equities, but “the mood was circumspect at best.”
One significant takeaway was that E&Ps “are highly unlikely to raise activity/capex at mid-year despite commodity price strength,” according to Evercore analysts. “Sentiment is that 2018 was a (failed) dress rehearsal for 2019 and increasingly those who make the decisions upstream are following the same script.”
Meetings with executives highlighted the “more mature nature” of the E&P industry and illustrated how the transition to lower growth and shareholder returns were overdue.
“Consistent with the 2019 outlooks, E&Ps are coalescing around similar themes. Spending within cash flow, with visibility toward free cash flow, and a commitment to how much of this free cash flow is coming back to shareholders are recurring discussions.”
Investors have been quick to test the discipline outlook, according to Evercore, asking if and how capital programs could change in a higher commodity price environment.
“The answer was definitively ‘no’ and more significantly, there was a significant focus on efficiencies and how level set, steady state development programs particularly in shale plays will continue to provide benefits.”
According to Tudor, Pickering, Holt & Co. (TPH), investors are “rightfully cautious in trusting management teams to stick to their word on the capital discipline mantra that has been loudly trumpeted.”
In a note to clients, TPH analysts said previous cycles would suggest that higher oil prices might lead to accelerated capex “and, as illustrated in 2018, with enough spending the U.S. is capable of oversupplying global demand, at least for the next few years.”
A sticking point for the long-only investors is that senior management compensation has not shifted enough to reward a balance of growth and returns, according to TPH.
“To that end, this year's proxy statements will be of particular interest, and we suspect shareholders may press companies more aggressively to continue to change behavior via compensation metrics.”
The recent rally in WTI oil prices hasn’t yet gained much traction, “as the specter of 2018 growth and a decade long track record around capital allocation has clients wary that higher oil prices could spur an acceleration of activity, which in turn would lead to lower long term commodity assumptions.”