U.S. oil prices above $50 a barrel are helping the shale patch to generate more cash flow, especially after the massive capital spending cuts last year. But higher prices are also reviving the good old dilemma of U.S. shale producers—raise production or raise payouts to shareholders, who have grown increasingly frustrated in recent years with the lack of meaningful returns while drillers were sinking cash flows, and even spending beyond cash flow generation into breaking production records.
Most analysts believe that this time around, there won’t be much of a dilemma as shale producers will have to show investors they can be more profitable, return more of those profits to shareholders, and “not drill themselves into oblivion,” as Harold Hamm warned the industry back in 2017.
As oil prices are steadying above $50 per barrel, producers are vowing, once again, capital and drilling restraint, while distributing more cash to shareholders now that the shale patch is set to generate higher cash flows.
While the prevailing opinion among analysts is that drillers would really keep their promise this time—unlike all similar pledges of the past four years—there is concern that the shale patch would return to plowing the cash it generates into drilling instead of into dividends.
In addition, some of the larger publicly traded shale-focused producers fear that smaller privately-held drillers would rain on their parade by boosting production again because the scale of production is their way of generating cash, and there is no judgment about their choices from the stock market or shareholders.
Despite the turbulent last year and the collapse in oil prices, 33 of the biggest listed shale-focused producers generated in the third quarter of 2020 the strongest free cash flow since the dawn of the fracking boom, the Institute for Energy Economics and Financial Analysis (IEEFA) said in an analysis in December. The companies generated $2.6 billion in free cash flow for Q3, thanks to the slashed capital expenditures (capex) during the quarter to the lowest level in more than a decade.
If WTI Crude prices average $50 a barrel this year, shale operators in the Permian Midland, Permian Delaware, Eagle Ford, Bakken, and DJ basins are set to see their cash flow operations jump to $73.6 billion in 2021, up from an estimated $55.7 billion in 2020, Rystad Energy forecasts.
Higher cash flow from operations and free cash flows at U.S. shale producers would allow them to finally start rewarding shareholders with increased payouts, potentially reversing the trend of pullback from investors, who have grown weary of seeing record production growth at the expense of payout growth.
“It is going to be a banner year for free cash flow to shareholders,” Dane Gregoris, a director at oil and gas data analytics company Enverus, told Reuters’ Jennifer Hiller.
To get more cash to shareholders, some companies are considering the introduction of variable dividends on top of the base dividend.
Pioneer Natural Resources, for example, will be working out the mechanics of a variable dividend early this year, payable in 2022, as long as the all strip price is $45 or higher for Brent, CEO Scott Sheffield said as early as on the company’s Q2 earnings call in August 2020.
Devon Energy, which authorized a special dividend last year, said in the announcement of the merger with WPX Energy that the combined company would launch a new dividend strategy that pays a fixed dividend and evaluates a variable distribution on a quarterly basis. Up to 50 percent of the remaining free cash flow on a quarterly basis will be distributed to shareholders through a variable distribution, Devon said in September.
Apart from higher dividend distribution, shale drillers vow restraint in production growth, but larger listed producers are concerned that some producers would break promises of output restraint.
“There are going to be bad actors [who pursue] growth for growth’s sake,” Matthew Gallagher, an executive at Pioneer Natural Resources, told the Financial Times.
Still, the shale industry is under increased pressure from investors to boost payouts to shareholders. According to Wood Mackenzie’s David Clark and Alex Beeker, “the strategic imperative is to deliver cash to shareholders through the cycle.”
Oil prices above $50 a barrel will put to the test the shale patch’s resolve to boost returns to shareholders and not sink all the cash into drilling. Investors may not give the industry another chance.