For years, shale companies burned through cash to grow production, a strategy that promised future returns even at the cost of a sharp increase in debt. The problem was that, by and large, the vast majority of shale companies have come up short, failing to turn a profit even as production soared. They added barrels to the market at an amazing clip, but shareholders have been left disappointed.
The dramatic cost cutting and lowering of breakeven prices over the past year or two offered yet another promise to investors. The days of reckless drilling were gone and the leaner and meaner shale operators would finally become profitable. Countless news articles hyped the extremely low breakeven prices. But right up through this year, the promise of big profits has continued to prove elusive.
Shale investors were fed up with the debt-fueled shale boom and pressed oil executives throughout 2017 to make changes. Activist investors demanded changes to executive compensation, a conservative and restrained approach to spending, and a focus on profits over growth.
The pressure to emphasize cash flow and profits seems to have finally led to change. In the past few months, shale companies of all sizes talked up their shift in strategy. Anadarko Petroleum, for example, announced a share buyback program a few months ago and its share price soared. Some of its peers, on the other hand, continued to announce aggressive production targets––a move that was not received as well on Wall Street.
Still, a growing number of companies have announced a shift in focus. To listen to shale executives at third-quarter earnings time “was to hear actors auditioning for the same part, reading the same lines from the same script,” Dan McSpirit, a BMO Capital Markets Corp. analyst, wrote in a note in November, according to Bloomberg. “The story was about capital discipline or growth within cash flow or some variation of it.”
But some of those decisions began to occur at a time when WTI was wallowing below $50 per barrel. The big question was whether shale companies would abandon restraint when WTI moved up, perhaps closer to $60 per barrel. Moreover, the extension of the OPEC deal arguably puts a pretty hard floor beneath oil prices, taking away a lot of risk for shale drillers heading into 2018. Share prices for dozens of shale companies skyrocketed last week when OPEC announced the extension.
So, surely it’s full speed ahead for shale growth? Not just yet. A few of the largest U.S. shale companies insisted that they would keep a laser focus on profits at the expense of growth, even after the OPEC announcement. Bloomberg surveyed three shale companies to see how they would respond. “Higher oil prices can bring in more cash to the balance sheet, and you can enjoy that cushion, but there’s no need to chase additional activity,” Matt Gallagher, Parsley Energy’s COO, told Bloomberg on the sidelines of an industry conference in Singapore. “It’s paramount that you’ve got to be disciplined and give visibility on spending.”
“If oil prices are higher, that means our cash flow may turn positive that much sooner, but no real change in activity level,” Pioneer Natural Resources’ Chief Financial Officer Richard Dealy said.
At the same time, these larger shale companies don’t decide everything. They seemed a bit nervous that smaller, more aggressive shale companies might drill with a sort of reckless abandon. “I hope they are more disciplined this time around,” Pioneer’s Dealy said.
“I don’t like $27 oil, but I don’t like $80 oil either,” Gary Packer, COO for Newfield Exploration, told Bloomberg. “Inefficiencies get bred into this industry at high commodity prices, and I think we have built efficiencies within the unconventional space to deliver exciting returns for our shareholders in a $50 environment.”
The top shale companies still want to see production growth, but only if in doing so they can generate strong cash flow, which would allow for higher returns for shareholders. The changes underway in the shale industry highlight how much influence Wall Street has over the shale business. If the profits aren’t there, the growth no longer will be.
“What we’re hearing today from our investors is they want to see more discipline,” Newfield’s Gary Packer told Bloomberg. “If investor behaviors change and they start rewarding production growth again, it can be a different outcome, but that’s not the narrative that we have today.”