Caution, capital discipline, cash flow, shareholder returns – these buzzwords are thrown around a lot these days, much more so than details about aggressive production growth. After years of a debt-fueled shale boom, drillers are under intense pressure to only spend within their means. For years, investors and shareholders have been demanding prudence from shale companies rather than growth-at-all-costs. But over the past year, the changes have finally become visible in the shale patch.
Shale profits have been elusive, but the industry could post positive cash flow essentially for the first time this year. The turnaround is the result of cost-cutting, lowering breakeven costs, and a rally in oil prices over the past year.
But that doesn’t meant that Wall Street is still in love with the shale industry, at least not the way it used to be. After getting burned by shale drillers for years, major investors are now demanding restraint…and returns on investment. “Don’t just drill, drill, drill,” Kevin Holt of Invesco, told the FT. “You have got to have a value proposition.”
That was the message sent repeatedly over the past year, but there is now a body of evidence to suggest that the investors, rather than shale executives, are increasingly in control. The stock prices of shale companies have increased when cash is returned to shareholders, whereas drillers that have continued to pursue a growth-model have been punished by Wall Street.
Last year, Anadarko Petroleum was one of the first to use its extra cash to launch a share buyback program. Its share price jumped on the news.
The experience of other companies that have continued to ramp up spending has been starkly different. Concho Resources just announced a pricey acquisition of RSP Permian for about $9 billion, a purchase that would make it the largest producer in the Permian.
Such a strategic move might have been rewarded in the past, but the company’s share price lost 9 percent immediately after the announcement – a signal from shareholders that they no longer want splashy moves. The FT notes that a sample of the 10 top U.S. shale companies have declined by 20 percent this year, but the ones that have prioritized shareholders have only lost 5 percent.
“What we are trying to do in this cycle is say: don’t make the same series of mistakes as in the past,” Kevin Holt of Invesco said in the FT interview.
It isn’t just small- and medium-sized shale companies that are coming around to a more disciplined approach. The WSJ notes that the share price of ConocoPhillips has outperformed its larger competitors ExxonMobil and Chevron. The difference is that Conoco has downsized since the collapse of oil prices began in 2014, selling off costly assets in order to improve its balance sheet and dish out rewards to shareholders. In 2015, the company even announced an exit from the offshore sector, stating that it would end exploration and focus its money on onshore shale.
ExxonMobil and Chevron have also sold some assets, but have purchased others, and continued to expand through the three-year oil market bust. In fact, Exxon recently announced a massive increase in long-term spending – its capex will jump by 25 percent beginning in 2020. It is in the midst of large-scale development of its offshore oil discoveries in Guyana, and it also recently announced plans for a major refinery expansion along the U.S. Gulf Coast.
The huge outlays were met with a selloff in Exxon’s share price, a clear sign that aggressive growth has fallen out of favor with Wall Street. Instead, investors are looking for something more stable and conservative. “The oil-and-gas industry is on its way to transitioning to a more mature market in the U.S.,” Tim Beranek, an asset manager for Cambiar Investors, told the WSJ. “Over the last decade, with the evolution of shale, it was an emerging industry and attracted a lot of growth investors. Now, the shareholder base just wants return on capital.”
Oil prices are significantly higher than they were a year ago, but energy stocks writ large are not. That suggests investors are either down on energy more broadly, or don’t trust the oil price rally. Still, the companies that are keeping their spending in check are the ones most favored by Wall Street.