As an industry matures, it’s not unusual for the pace of growth to moderate. For public E&Ps, who traditionally have been rewarded mainly for growth, this raises an issue. Will their investor base—often at pains to preach capital discipline to the energy sector—follow through with support if E&Ps shift gears from a growth mantra to a mix of moderate growth, dividends and stock buybacks?
Historically, the instinct of E&Ps has been to let the “other guy” be first to cut production, since this typically has been associated with a sell-off in an E&P’s stock. But, signs point to greater acceptance of more measured growth, certainly among larger E&Ps, as the industry matures.
EQT Corp. CEO Steve Schlotterbeck, following the natural gas producer’s deal to acquire Rice Energy Inc., said the industry has transitioned from phase one to phase two of the shale gas revolution.
“It’s my belief we’re in the second phase of the shale gas revolution, and the high-growth models of the first phase aren’t going to work in phase two. We need to be focused on creating real value and getting that value directly back to shareholders,” said Schlotterbeck. “The grow-as-fast-as-you-can-at-any-cost model, while probably necessary early in the shale revolution, doesn’t work anymore.”
Admittedly, size matters, and EQT now enjoys a highly concentrated base in Appalachia of 1 million acres pro forma for the acquisition. (See the Executive Q&A in this issue.) EQT will have “the leading natural gas cost structure in the country,” said Schlotterbeck, “with a long runway of opportunity. I think that will generate the ability to grow at pretty attractive rates while giving cash back to shareholders.”
EQT is targeting cash-flow breakeven in 2019 and returning cash to shareholders in 2020. And similar questions are also increasingly being asked of rapidly growing small-cap E&Ps, even though their growth trajectory is currently incompatible with returning cash to shareholders, according to one small-cap Appalachian E&P.
For those with free cash flow already in their sights, adjusting a long-term plan for fluctuating oil prices is not without problems.
Pioneer Natural Resources Co.’s 10-year plan projects the company being cash-flow neutral in 2018 and generating free cash flow in 2019. But, this assumes a price deck of $55 per barrel and $3 per thousand cubic feet. With oil prices at the time hovering in the low to mid-$40s, Pioneer CEO Tim Dove said changes, if needed, would be made so “we’re not going to drill ourselves into oblivion.”
However, given lags before changes have an impact, operations would be largely unaffected in 2017 and 2018, said Dove. If oil stayed at $45, Pioneer could “throttle back at the margin” and lower spending in the Eagle Ford and on infrastructure buildout. Drilling would not cease altogether, as that would mean missing out on low oilfield service costs—a “huge mistake.”
As EQT has demonstrated, E&Ps can have more than one path to growth, with strategic acquisitions supplementing organic growth. Other E&Ps are also open to a strategic mix.
For example, Appalachian producer Eclipse Resources Corp. can boast a stout three-year compound annual growth trajectory of 25%. Yet, CEO Ben Hulbert is eyeing possible acquisitions—in part to bolster discount valuations assigned to small-cap E&Ps—while remaining open to eventual consolidation.
“There’s definitely a negative bias toward small caps right now,” said Hulbert. “The way for us to fix it is to get bigger. I do think there will be continued consolidation in the basin. We’d love to consolidate and then probably get consolidated.”
A note by J.P. Morgan pointed to possible consolidation also occurring in the Permian.
“Management teams and investors alike believe consolidation, particularly in the Permian, can begin to heat up in 2018,” it said. This would likely occur “as the last remaining privates potentially sell out and execution for public smid-caps perhaps becomes an issue during the second half.”
But back to E&Ps’ reluctance to rein in production: Do investors exacerbate pressure on E&Ps by selling down their stocks if they moderate growth targets?
Investors should “stop rewarding growth and reward efficiency,” said Anadarko Petroleum Corp. CEO Al Walker. “If you keep rewarding growth without return, you’re just helping to compound the problem that we have today.”
And, if production growth pressures commodity prices, capital markets have little appetite to shore up balance sheets again, warned a recent Tudor, Pickering, Holt & Co. note.
“Universally, both hedge funds and long-only analysts and PMs [portfolio managers] stated they had little to no interest in providing a second lifeline to the industry.”
Recommended Reading
Triangle Energy, JV Set to Drill in North Perth Basin
2024-04-18 - The Booth-1 prospect is planned to be the first well in the joint venture’s —Triangle Energy, Strike Energy and New Zealand Oil and Gas — upcoming drilling campaign.
TotalEnergies Cements Oman Partnership with Marsa LNG Project
2024-04-22 - Marsa LNG is expected to start production by first quarter 2028 with TotalEnergies holding 80% interest in the project and Oman National Oil Co. holding 20%.
Is Double Eagle IV the Most Coveted PE-backed Permian E&P Left?
2024-04-22 - Double Eagle IV is quietly adding leases and drilling new oil wells in core parts of the Midland Basin. After a historic run of corporate consolidation, is it the most attractive private equity-backed E&P still standing in the Permian Basin?
TotalEnergies to Acquire Remaining 50% of SapuraOMV
2024-04-22 - TotalEnergies is acquiring the remaining 50% interest of upstream gas operator SapuraOMV, bringing the French company's tab to more than $1.4 billion.
EIG’s MidOcean Closes Purchase of 20% Stake in Peru LNG
2024-04-23 - MidOcean Energy’s deal for SK Earthon’s Peru LNG follows a March deal to purchase Tokyo Gas’ LNG interests in Australia.