First quarter earnings for the energy majors and a slew of big U.S. independents will take the spotlight this week, with financial leverage likely to be on the minds of investors and analysts.
For the energy majors, BP plc is set to release its results on Tuesday. Equinor ASA, Repsol SA and Royal Dutch Shell plc’s first quarter results are scheduled for Thursday. ExxonMobil and Chevron Corp. will close the week on Friday, along with Mexico’s state-owned Petróleos Mexicanos, aka Pemex.
Some of the Lower 48’s biggest exploration and production (E&P) companies also will issue their results, including Cabot Oil & Gas Corp., Continental Resources Inc., Hess Corp., Ovintiv Inc., Range Resources Corp. and Ring Energy Inc.
Tudor, Pickering, Holt & Co. analysts are expecting a “quiet quarter,” as many upstream operators have pre-released their production and realization estimates, along with the impact related to the February freeze from Winter Storm Uri.
“While not every company has provided an update to production, most have given some color/guidance on the first quarter to account for the volume impacts from winter storm Uri,” the TPH analysts said.
Natural Gas Benefits
Permian Basin volume expectations took the biggest hit from Uri, TPH’s team noted. However, there has been an “unexpected benefit,” based on some preliminary E&P reports for “significantly better than expected” natural gas realizations. Higher natural gas liquids (NGL) prices are providing needed support too.
In some cases, the gas realizations have been $4-6/Mcf, according to TPH, “which has actually driven upside to first quarter cash flow estimates. That being said, this has likely been reflected in estimates as the buyside and sell side have trued up models heading into earnings.”
The TPH analysts expect upstream operators to share their capital allocation plans given higher oil prices. However, they “fully anticipate public E&Ps to continue to toe the line on maintenance capital plans for the remainder of the year.
Holding the line will not come until global inventories normalize, the Organization of the Petroleum Exporting Countries reverses curtailments, and additional debt is paid down, the TPH analysts said.
Many analysts are keeping an eye on the private E&Ps, as their activity, unshackled from investor pressure, has eclipsed that of many of the publicly held operators.
“While we think the majority of investors are bullish on crude, private E&Ps are the least understood wildcard for U.S. oil with consensus being that privates are ‘bad actors’ on capital discipline relative to their public counterparts,” Barclays Capital analyst Jeanine Wai and her team said.
After speaking with principals ahead of first quarter results at Chevron, ExxonMobil and some of their covered E&Ps, Barclays analysts said they could “confirm that discipline among the larger public upstream players is strong despite the price rally.” Private E&Ps are ramping up the oil rig count, “which validates the capital discipline bear thesis for the privates, and private Permian oil production sensitivity to reinvestment rates and prices.”
What’s at issue, though, is the lack of clarity on private E&P operating strategies or their financials. Getting a handle on what private E&Ps can bring to the table became a bit clearer earlier in April. Permian Basin heavyweight Pioneer Natural Resources Co. agreed to pay $6.4 billion for privately held West Texas competitor DoublePoint Energy LLC.
While there are material differences in productivity for private versus public E&Ps, it’s not enough to “overcome drastic activity disparities,” the Barclays analysts said. “Privates are too big to ignore on the macro front.”
Private E&Ps currently comprise 43% of the horizontal U.S. land oil rig count and were responsible for an estimated 34% of 2020 U.S. tight oil production, according to Barclays. For now, the private oil rig ramp-up “far exceeds” the public E&Ps in price recoveries.
While the private E&P horizontal land oil rig count troughed in early July at 38 rigs, it’s been moving higher ever since. The privates have added around 99 rigs since for a 261% increase. That compares with the public E&Ps, which as of earlier this month had added around 67 total rigs or a gain of 59%.
Still, the Lower 48 rig count is not the whole story.
An analysis by Barclays of New Mexico and Texas data indicated that private oil well productivity in the Permian has materially lagged public E&P output for years. In a 12-month cumulative oil/lateral foot basis, private E&P productivity in the Permian “widened to 27% worse than that of the public’s in 2020.”
Still, merging private and public E&Ps as in Pioneer’s case appears to make sense — and could be a sign of things to come.
“Constructive oil prices, capital discipline and cash returns are necessary for energy to be attractive,” the Barclays analysts said. “In the Permian there isn’t a ton of larger public to private deals left as private E&Ps are a disparate group.”
Private E&Ps account for around one-third of U.S. tight oil output. Assuming an 85% reinvestment rate, private E&Ps are forecast to increase their Permian oil production by slightly more than 200,000 b/d from 4Q2020 to 4Q2021. However, “the supply response from this group could be significantly higher if prices or reinvestment rates exceed our expectations,” Wai said.
Barclays analysts are fielding questions about how impactful the private E&P activity could be on domestic oil growth. The consensus view is that private E&Ps tend to be less disciplined than the publics as they face less accountability by the market. The common question asked is “could the privates ruin it for everyone?”
Breaking it down, the privates accounted for 31% of Lower 48 oil production during December, or 34% of fiscal year 2020 tight oil production, according to Barclays. Ten years ago the privates accounted for around 75% of tight oil output. Notably, privates also now comprise 43% of the total horizontal land oil rig count in the United States, versus 29% a year ago.
The private E&Ps are able to respond faster to improving West Texas Intermediate (WTI) prices, and the rig ramp goes in tandem with prices. For example, WTI turned negative in April 2020 at minus $37.64/bbl. Privates began tacking on rigs “exactly 11 weeks later,” in early July. Meanwhile, the public E&P rig count didn’t pick up until 20 weeks later, in early September.
Barclays analysts surmised that private E&Ps are “more likely to take advantage of the current ‘Goldilocks’ period of constructive oil prices and lower costs in order to maximize near-term cash flow while the markets hold back public production growth as a proxy for capital discipline. Thus, we think the risk for private oil production is skewed to the upside.”
‘Robust’ NGL Outlook
Goldman Sachs analysts are expecting E&Ps to issue “noisy” 1Q2021 results, in part on the freezing weather disruptions during February, which shut down some of the most active oil and gas fields in the Lower 48. There’s likely to be commentary about the potential for more merger and acquisition (M&A) activity, along with capital discipline, free cash flow and strong NGL pricing.
The NGL outlook “remains robust, with strong uplift expected in 1Q2021,” the Goldman team said. “Strong NGLs prices can be a tailwind for liquids producers.” The constructive NGL outlook in the near term is in part because of expectations for a strong demand recovery, higher gross domestic product and continued U.S. E&P discipline.
“Specifically within NGLs, we are most constructive on propane,” analysts said. “U.S. propane and propylene inventories are at their lows relative to the five-year average, which we expect will drive the need for propane prices to be priced favorably relative to naptha as a feedstock for crackers.”
One big question is whether E&Ps will remain on the path of fiscal constraint or be lured by higher commodity prices. Goldman analysts think restraint will be the mantra for capital expenditures (capex).
“We believe managements will remain committed to their reinvestment rate frameworks calling for reinvestment of 65-80% of cash flow to capex, despite the move higher in oil prices since budgets were set. What we believe will be key for investors is whether producers stick to their strategies, including 0-5% growth, longer-term.”
Goldman expects WTI could climb as high as $77/bbl in the second half of the year. Still, “we think continued messaging of disciplined growth will be needed to mitigate investor concerns regarding erosion of discipline over time.”
Goldman’s team, like Barclays, noted the disproportionate additions to the U.S. rig count by private E&Ps over public operators. The bulk of rig activity by the public Lower 48 E&Ps is “near maintenance levels from an activity perspective. Of note, rig activity from majors,” including BP, Chevron and ExxonMobil, “still sits below rig count at the July 2020 bottom.”
Analysts led by Devin McDermott of Morgan Stanley & Co. LLC said if E&Ps execute and reiterate disciplined spending plans during this earnings season, it “should help to solidify investor confidence in the sector’s improving FCF story.”
For E&Ps, it remains a “show me” story for investors, McDermott and his team said. The sector has been trading at a 25% discount to net asset value implied prices even with FCF yields that are three times the broader market.
“Heading into first quarter earnings, consistent messaging and execution of disciplined capital plans will be key to restore confidence in the sector’s new model of sustainable FCF generation,” according to the Morgan Stanley analysts.
The weather impacts from the extreme cold during February are likely to be transitory, according to Morgan Stanley and other analyst teams. Besides strong NGL pricing, the lack of oilfield services inflation should provide another tailwind to capex for 2021.
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