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U.S. Corporate Cash Reaches $1.9 Trillion But Rising Debt and Tax Reform Pose Risk

Several majors could make a play for Permian producer Endeavor Energy

IEA warns of oil supply lagging demand without significant investment

Permian producers prepared for dip in oil prices to last into 2019

Stocks Rocked the House Post Midterm Elections


U.S. Corporate Cash Reaches $1.9 Trillion But Rising Debt and Tax Reform Pose Risk

Wealth inequality in the U.S. isn't just for individuals; the divide between the haves and the have-nots continues to widen for American companies too. In fact, of the roughly 2,000 U.S. nonfinancial corporate borrowers S&P Global Ratings rates, just 25--or the top 1%--hold more than half of the record $1.9 trillion in cash and short- and long-term liquid investments as of year-end 2016 (see Methodology section). This now $1 trillion hoard is nearly twice the $510 billion they held just five years ago. Moreover, while all corporate cash grew a significant 10% last year, from $1.7 trillion at the end of 2015, the imbalance between cash and debt outstanding that we highlighted last year persists, with total debt rising approximately $350 billion, to $5.8 trillion.

To be sure, the top 1% have more than enough cash to repay their total debt of about $750 billion. But for the other 99%, credit risk remains. These issuers hold just $875 billion in cash against a whopping $5.1 trillion in debt, putting their cash-to-debt ratio at just 17%--the lowest since the 16% seen in 2008. Improving profitability hasn't offset the debt either; S&P Global Ratings' adjusted leverage is near a decade high of 2.5x for investment-grade borrowers (excluding the top 1%) and 5.0x for speculative-grade companies.

Overview

  • Cash and investments held by S&P Global Ratings' universe of rated U.S. nonfinancial corporate issuers rose by 10% to $1.9 trillion in 2016 as the rich get richer: The top 1% control more than half of this cash pile.
  • But rising debt, now at a collective $5.1 trillion for the 99%, is a concern: Adjusted leverage for both investment-grade and speculative-grade issuers is near decade highs and, conversely, the cash-to-debt ratio near decade lows.
  • At the same time, tax reform that facilitates the repatriation of roughly $1.1 trillion in cash held offshore would likely spur a wave of share repurchases, leading to lower cash balances and potentially weaker credit metrics.

Meanwhile, if the Trump Administration succeeds in passing tax reform that facilitates the repatriation of foreign earnings, we envision that a material amount of the estimated $1.1 trillion held overseas will return--and could be distributed to shareholders through dividends or share repurchases. The resulting depletion of cash, if not offset by some debt repayments, could raise borrowers' adjusted leverage and, in turn, weigh on their credit metrics and our view of their financial policies--especially in the cash-rich technology and health care sectors. Indeed, 2017 may spell the end of the great cash hoarding by U.S. borrowers.

Cash And Investments Reach Another High

The $1.92 trillion in cash held by the U.S. nonfinancial corporate borrowers we rate represents an increase of 10%, or $170 billion, from a year earlier--growth that outstrips the modest increase in our rated universe (see chart 1). The overall cash total has nearly doubled in the past seven years, while the number of borrowers we rate has increased 60%.

Chart+1+-+Cash+Reaches+1.9+Trillion+US+Dollars

The cash hoarding, which began in response to jurisdictional tax disparities and global economic uncertainty following the Great Recession, accelerated over the past decade as large U.S. corporations maneuvered to accumulate profits offshore in lieu of repatriating the funds and taking a tax hit. The top 1% now hold over $1 trillion in cash, double the $510 billion reported just five years ago. The technology sector leads all industries with 44%, or over $800 billion, of the total cash, followed by health care (mostly pharmaceutical companies) at 13%, or over $200 billion (see chart 2). These two industries have particularly high proportions of their cash overseas because they accumulate much of their profits in non-U.S. countries, where most of their intellectual properties are registered.

Chart+2+-+Technology+and+Health+Care+Account+for+More+than+Half+of+the+Cash

Beware of Debt

While record cash balances make for good headlines, the more important story, in our view, is that total debt outstanding has risen roughly $2.2 trillion, to a record $5.8 trillion in the past five years (see chart 3). As it stands, cash as a percentage of debt is at 33% for U.S. corporates overall.

Chart+3+-+Total+Debt+Outstanding+Continues+to+Rise

Removing the top 25 cash holders from the equation paints an even more sobering picture. Total debt among the bottom 99% jumped nearly $200 billion to $5.1 trillion last year, while cash rose just $60 billion to $875 billion. Some of this is attributable to the mostly speculative-grade new issuers we rated. But borrowing up and down the credit ladder continues to fuel most of the increase. In particular, many corporate sectors face modest organic revenue-growth prospects. As a result, some companies have expanded through acquisitions, often funding the acquisitions with debt. Others, mostly sponsor-owned companies, have opportunistically tapped the capital markets with favorably priced debt, at the cost of higher leverage.

We note that speculative-grade borrowers' cash-to-debt ratio is at a decade low of 13%--a significant drop from the 21% reached in 2010, and even below the 15% in 2008 during the Great Recession (see chart 4). In other words, after adding $200 billion of debt last year, these borrowers now have almost $8 of debt for every $1 of cash. (We also note that they borrowed significant amounts under extremely favorable terms in a relatively benign credit market without effectively improving their liquidity profiles.)

We see a similar trend among highly rated borrowers. The more than 500 investment-grade companies that aren't among the top 25 have cash-to-debt ratios more similar to those of speculative-grade issuers than to those in the top 1%. Their collective cash-to-debt ratio now stands near a decade low of 21%, indicating a balance sheet of $5 of debt for every $1 of cash. These issuers are generally conservative, yet the lure of cheap money continues to drive acquisitions and shareholder rewards.

Chart+4+-+Cash+to+debt+Ratios+Are+Near+Decade+Lows

Improving Profitability Does Not Offset Rising Debt

Profitability has been rising steadily, though unspectacularly, since the Great Recession. S&P Global Ratings adjusts leverage by netting what we consider to be surplus cash--generally taking a haircut of as much as 35% on overseas cash, among other adjustments--to arrive at an adjusted leverage (in contrast to gross or net leverage). Adjusted leverage has consistently trended higher in the past five years for all ratings categories (see charts 5 and 6). Investment-grade borrowers' leverage has risen by more than half a turn to 2x since 2013. Removing the top 1%, many of whose leverage is zero due to their net cash positions, yields a higher leverage of 2.5x for investment grade. Speculative-grade borrowers share a similar trend, with leverage rising by nearly a turn to almost 5x.

Chart+5+-+Leverage+is+Rising+for+all+-+Investment+Grade

Chart+6+-+Leverage+is+Rising+for+all+-+Speculative+Grade

Top 1% Are Hoarding Cash … For Now

In 2016, the top 1% improved their collective cash position by $130 billion, to $1 trillion (see table 1). Their cash-to-debt ratio remains near the 140% area, or more than 8x better than that of the other 99% of borrowers. In 2016, these companies' total debt outstanding rose by almost $200 billion, exceeding their cash growth, as companies continued to borrow as a form of "synthetic" cash repatriation.

Despite the increase in debt, we generally view their financial policies as conservative, as indicated by their strong net cash position. The cash flow of the top 1% remains healthy and could support significant shareholder returns. But their unwillingness to repatriate overseas cash, along with an accommodative credit market, has continued to fuel the rising debt load. Technology companies, which were debt averse even a decade ago (to guard against potential industry downturns and to maintain liquidity for acquisitions and investments) have become prominent borrowers in recent years. For example, Apple has borrowed nearly $100 billion in the past four years to fund share repurchases.

Table 1
Top 25 Issuers with the Largest Cash Holdings as of 2016

Rank Company Rating as of May 22, 2017 Cash and marketable investments Total Debt Cash year over year Debt year over year
1 Apple Inc. AA+ 246.1 87.5 30.4 24.6
2 Microsoft Corp. AAA 130.1 87.8 17.0 43.4
3 Alphabet Inc. AA+ 86.3 3.9 13.3 (1.3)
4 Cisco Systems Inc. AA- 71.8 34.9 11.8 10.3
5 Oracle Corp. AA- 59.4 53.0 8.6 12.9
6 Johnson & Johnson AAA 41.9 27.1 3.5 7.3
7 Amgen Inc. A 38.1 34.6 6.7 3.0
8 Gilead Sciences Inc. A 32.8 26.3 6.6 4.2
9 Qualcomm Inc. A 29.8 11.7 (0.8) 0.7
10 Ford Motor Co. BBB 27.5 15.9 3.9 3.1
11 Amazon.com Inc. AA- 26.0 20.4 6.2 2.9
12 Merck & Co. Inc. AA 25.8 24.8 (0.7) (1.7)
13 Pfizer Inc. AA 23.0 42.1 (14.3) 3.1
14 The Coca-Cola Co. AA- 22.2 45.7 2.3 1.5
15 Intel Corp. A+ 22.1 25.3 (6.1) 2.6
16 General Motors Co. BBB 21.6 10.8 1.3 2.0
17 Abbott Laboratories BBB 18.8 22.0 12.7 13.0
18 PepsiCo Inc. A+ 16.1 36.9 4.1 3.7
19 Dell Technologies Inc BB+ 15.3 49.4 15.3 49.4
20 Procter & Gamble Co. AA- 13.5 29.5 (0.8) (2.1)
21 Walgreens Boots Alliance Inc. BBB 11.8 18.9 8.2 4.9
22 eBay Inc. BBB+ 11.1 9.0 1.6 2.2
23 Eli Lilly & Co. AA- 10.7 10.3 3.1 2.3
24 General Electric Co. AA- 10.7 20.5 0.1 2.0
25 Boeing Co. A 10.0 10.0 (2.0) 0.0
Total 1,022.3 758.4 131.7 194.0
Year-over-year change 15% 34%

Overseas Cash Hoard Is Near $1.1 Trillion

Most companies don't report their cash holdings by region. But we've found that the top 15 cash holders that do so increased their overseas cash balances by $100 billion last year (see table 2). Cash held outside the U.S. accounted for most of the growth in cash holdings, indicating that these large cash-rich issuers completely exhausted their domestic cash flow and chose to borrow in significant amounts in lieu of repatriation to fund shareholder returns. In all, these 15 issuers now hold 84% of their cash overseas, a significant increase from about 70% in 2012. As for the S&P Global Ratings-rated universe of nonfinancial corporates, we estimate that about 60%, or $1.1 trillion, of the $1.9 trillion is now held offshore.

Table 2
Overseas Cash Vs. Domestic Cash: For the Top 15 Issuers that Report Overseas Cash

(Bil. $)            
Company Rating as of May 22, 2017 Cash and investments Domestic % Overseas % Overseas Total Debt
Apple Inc. AA+ 246.1 15.9 230.2 94% 87.5
Microsoft Corp. AAA 130.1 13.8 116.3 89% 87.8
Alphabet Inc. AA+ 86.3 34.1 52.2 60% 3.9
Cisco Systems Inc. AA- 71.8 9.5 62.3 87% 34.9
Oracle Corp. AA- 59.4 7.2 52.2 88% 53.0
Johnson & Johnson AAA 41.9 0.6 41.3 99% 27.1
Amgen Inc. A 38.1 3.7 34.4 90% 34.6
Gilead Sciences Inc. A 32.8 5.4 27.4 84% 26.3
Qualcomm Inc. A 29.8 1.9 27.9 94% 11.7
Amazon.com Inc. AA- 26.0 20.1 5.9 23% 20.4
The Coca-Cola Co. AA- 22.2 8.5 13.6 62% 25.3
Intel Corp. A+ 22.1 8.5 13.6 62% 25.3
PepsiCo Inc. A+ 16.1 0.9 15.2 94% 36.9
Walgreens Boots Alliance Inc. BBB 11.8 10.2 1.6 14% 18.9
eBay Inc. BBB+ 11.1 2.9 8.2 74% 9.0
Total 845.6 136.7 708.9 84% 523.2

Tax Reform Is A Game Changer

Tax reform, specifically regarding repatriation, is of particular interest to S&P Global Ratings, given that we apply our surplus cash criteria to calculate debt when measuring credit metrics. Therefore, repatriation and the subsequent distribution of cash to shareholders could affect our adjusted credit ratios--although the effects on ratings would depend on each specific case and whether this represents a change in a company's financial policy. If we were highly confident that impending tax reform would lead to a change in a company's financial policy, we could incorporate these views into our existing financial policy assessments and forward-looking forecasts. While tax reform, in both specificity and timing, remains uncertain, we believe there is enough support among various constituents that some sort of reform facilitating the repatriation of overseas earnings is likely to become a reality in the next year or so.

In such a scenario, we believe most companies would repatriate meaningful amounts of overseas cash, largely for share repurchases, but also for acquisitions and some debt repayments. (See "Credit FAQ: What Impact Could Cash Repatriation Have On U.S. Corporate Credit Quality?" published Feb. 13, 2017 on RatingsDirect.)

Repatriation Will Have Major Impact On Technology

With its total cash holdings in excess of $800 billion, up to three-quarters of which we estimate may be held offshore, the technology sector stands to be affected most by repatriation. If tax reform is passed, we expect borrowers to immediately bring cash home, although the pace of repatriation will depend on each company's needs and the timing of tax payments due. More important, we expect an orderly distribution of excess capital, which we believe would be communicated to investors well in advance of actual repatriation.

Specifically, we expect share repurchases will increase significantly, although this would take place over multiple quarters, if not years, depending on the size of the cash position and repurchase authorization. Dividends would also likely increase, through both one-time special dividends and dividend hikes. While we don't think that mergers-and-acquisitions strategy will change meaningfully, given that most issuers have had access to credit markets for strategic takeovers, we note that borrowers would have greater strategic flexibility with cash onshore.

As for debt, we believe that some companies (mostly large, cash-rich companies) would set aside cash to pay off debt or meet upcoming maturities. Debt outstanding in the technology sector has grown significantly in the past five years, much of it through synthetic cash repatriation. In fact, Apple, Microsoft, Cisco, and Oracle alone were responsible for more than $100 billion of new debt issuance in 2016, a 10-fold increase from just five years ago (although part of Microsoft's debt issuance was attributed to its acquisition of LinkedIn). We believe borrowing among large technology companies may slow once cash is repatriated. As companies become more certain of the probability of tax reform, some may increase their use of commercial paper (CP) as a short-term measure, until they can pay down debt with repatriated cash.

Chart+7+-+Debt+Issuance+May+Slow+Once+Repatriation+is+Allowed

Health Care May Face Shareholder Pressure

The health care sector has the second-highest amount of overseas cash after the technology sector, much of the cash with pharmaceutical companies. While we believe that tax reform is a major long-term positive for the industry, we believe the ratings may be at risk over the near term given the increased possibility of shareholder-friendly actions that may drain the cash balances. Pharmaceutical companies have a range of options, including holding onto the cash, repaying debt, boosting research-and-development and capital expenditure, repurchasing shares, and paying dividends. We believe each company will likely do a combination of the aforementioned options, the mix of which will depend on each individual company and the financial aggressiveness of its management team.

We believe there will be some debt repayment and holding of cash onshore, but absolute debt levels at pharmaceutical companies are likely to decline only modestly given the still low-interest-rate environment.

We expect the pace of acquisitions to slightly increase in the pharmaceutical sector after tax reform. While acquisitions were down in 2016, the sector set a record pace for acquisitions over the past three years, as companies sought to diversify their pharmaceutical portfolios and deepen their prospect pipelines in the face of unprecedented pricing pressure from consolidated payers. That said, pharmaceutical companies have had more than adequate access to capital to fund acquisitions, so repatriation alone isn't enough to drive increased acquisitions. However, an increased number of attractive U.S.-based pharmaceutical assets could, in a post-tax-reform world, satisfy companies' internal return hurdles and lead to increased bidding.

Increased shareholder-friendly actions appear the most likely uses of the repatriated cash, although the size and likelihood of such activities will depend on each company and what level of shareholder pressure it is under to generate growth in the increasingly competitive pharmaceutical sector. Companies such as Gilead and Amgen, which both sit on over $30 billion of overseas cash and face slowing growth, may face shareholder pressure, and we would not be surprised should activists emerge to pressure select pharmaceutical companies. Indeed, ahead of tax reform, we may see pharmaceutical companies' net leverage start drifting up, as companies delay repatriation and issue more, potentially shorter-term, debt and increase CP utilization to fund operations while awaiting repatriation. Also, should tax reform become an increasing reality, pharmaceutical companies may increase share repurchase activity ahead of tax reform in anticipation.

Repatriation's Credit Impact Will Be Neutral To Negative

S&P Global Ratings views repatriation as a potential credit risk if issuers were to become more aggressive in their shareholder returns than what we assume in our forecasts and assessments of financial policy. We believe that the improved accessibility to offshore cash under proposed tax reforms could provide both economic incentives and pressure on management to revise its financial policies and capital allocation strategies. The depletion of surplus cash, if not accompanied by similar debt repayments, could raise adjusted leverage and, in turn, pressure credit metrics. While some borrowers could maintain similar levels of net cash by offsetting shareholder returns with debt reduction, many others are likely to determine that their large cash (and debt) positions were solely in response to tax constraints, and would no longer see a need to maintain such liquidity.

In all, we see a decline in net cash balances and, with it, rising leverage for some borrowers and reduced cushion for others. Specifically, the top 1% of borrowers alone could repatriate more than $700 billion over time and may return a significant amount of this cash to shareholders (although some cash would almost certainly go to pay down debt or meet upcoming maturities). That said, we don't expect this to lead to meaningful rating actions for the top 1%, as these borrowers would mostly be reducing their cushion with respect to the ratings.

On the other hand, borrowers who are cash neutral or in net debt positions despite having large cash balances--including some in the top 1% and many in the crossover categories of 'BBB' and 'BB'--will have to manage a delicate balance between equity holders and debtholders. If a borrower with limited ratings cushion opts to use most of the repatriated cash for repurchases, thus raising leverage per our calculation, we may review the company for a potential downgrade.

2017 May Mark The End Of Cash Hoarding

Cash growth among U.S. corporates has been a popular topic among investors over the past decade. It is a story of American economy's resilience, a tax policy that encouraged borrowing instead of repatriating, and a reflection of the growing divide between the haves and have-nots. As the cash on U.S. corporate balance sheets nears $2 trillion, we may be nearing the peak of the great cash hoarding. Simply put, we can't see U.S. companies continuing to build up cash at the current rate if tax reform facilitates the repatriation of foreign earnings.

Credit market conditions have been favorable for a long time, but leverage is near post-crisis highs and the credit cycle is aging. This raises the question of whether a decline in cash balances would be matched by an unwinding of debt.

We expect that most investment-grade borrowers and those at the stronger end of the speculative-grade spectrum will be able to adjust their operational and financial policies to absorb an expected steady climb in interest rates. But if access to capital markets becomes fragmented, liquidity risk could increase, especially for borrowers at the lower end of the ratings scale--in other words, those that can least afford it.

Given the dislocation in capital markets that occurred in 2008 and 2009--as well as the volatility we saw at the beginning of last year--we wouldn't be surprised to see some wariness among investors. Against this backdrop, future financings--particularly for borrowers in stressed sectors--could be at risk.

Methodology

The cash and investment figures referred to in this report include cash, short-term investments, and long-term liquid investments for nonfinancial corporate issuers rated by S&P Global Ratings at each year end. Unlike in prior years, cash and debt figures mentioned in this report exclude regulated utilities, as they are not considered part of S&P Global Ratings' corporate ratings. The report excludes issuers domiciled overseas who issue debt in the U.S. The report also excludes debt related to captive financing companies owned by issuers. We have made certain assumptions in an attempt to approximate overseas cash for the purpose of this analysis due to disclosure limitations.



Several majors could make a play for Permian producer Endeavor Energy

Oil majors Exxon Mobil Corp., Chevron Corp., Royal Dutch Shell PLC and ConocoPhillips are all considering making first-round bids for Texas-based oil producer Endeavor Energy Resources LP.

Including debt, Endeavor, which holds more than 300,000 acres in the prolific Permian Basin, could be valued at $12 billion to $15 billion. Core acres are located in Martin, Midland, Upton, Glasscock, Reagan and Howard counties. The company's net production in the second quarter was 64,000 barrels of oil equivalent per day, 75% of which was oil.

Many of the majors have highlighted their renewed interest in the U.S. shale plays. Having announced plans earlier this year to triple its Permian oil production to 600,000 barrels per day by 2025, Exxon is viewed by many as the most logical would-be buyer of Endeavor. Back in 2014, Exxon inked a seven-year deal with the producer to expand its presence in the basin.

Exxon's third-quarter shale oil output from the Permian was up 57% on the year due to the ramp-up to the current 38 rigs in the Midland and Delaware basins. The company's third-quarter Permian production increased 170,000 boe/d, or 11%, on the quarter.

While Chevron could be a contender, the company already has a sizeable position in the Permian, analysts said. "Chevron is another possibility although we think its existing position of 1.7 [million] acres (0.5 million Midland and 1.2 million Delaware) is likely adequate, with the focus likely to be more on acreage swaps and trades to core up its position," RBC analyst Biraj Borkhataria wrote in a Nov. 13 note.

Analysts said ConocoPhillips and Shell are less likely to emerge as bidders.

"Despite the company's positive disposition to the play, we would not expect Shell to bid for such a large package given the company has been clear that inorganic activity is included within its $25 [billion] to $30 [billion] capex framework per annum, meaning limited headroom to execute such a large deal," Borkhataria said.

Should a sale occur, it would follow a rash of Permian-based transactions, including Concho Resources Inc.'s purchase of RSP Permian for $8 billion and Diamondback Energy Inc.'s purchase of Energen Corp. for $9.2 billion. Additionally, on Oct. 31, BP PLC closed on its $10.5 billion acquisition of BHP Billiton Group's U.S. shale oil and natural gas assets.

In emailed requests for additional details on a sale, officials from Endeavor, Exxon, Shell and ConocoPhillips declined to comment. An inquiry to Chevron was not immediately returned.

Endeavor, which is family owned, agreed to explore a sale after receiving inquiries from prospective bidders, although the family reportedly would prefer an IPO next year so it could retain control. JP Morgan Chase & Co. and Goldman Sachs Group Inc. were reportedly selected to arrange the possible transaction.



IEA warns of oil supply lagging demand without significant investment

The International Energy Agency warned in its World Energy Outlook 2018, released Nov. 13, that without sufficient oil production investment, the world faces a possible oil supply gap during the early 2020s.

"Oil and natural gas will be part of the energy system for decades to come — even under ambitious efforts to reduce greenhouse gas emissions in line with the Paris Agreement," the report said.

Under existing and planned policies included in the report's new policies scenario, trucking and aviation demand will drive global oil consumption to 102.4 million barrels per day by 2025. Meanwhile, the IEA projects currently producing oil fields will supply just 68.0 MMbbl/d.

"The level of conventional crude oil resources approved for development in recent years … is only half of the level needed to meet demand growth in the [new policies scenario]," the report said.

"If these approvals do not pick up sharply from today's levels, U.S. tight oil production would need to triple from today's level to over 15 [million barrels per day] by 2025 to satisfy demand," the report said. "With a sufficiently large resource base, this could be possible. But it would require levels of capital investment that would far surpass the previous peaks in 2014."

Among trends to 2040, the IEA outlined a "major shift in the geography of oil demand."

According to the report, developing economies will see oil demand grow by 18 MMbbl/d from 2017 to 2040, offsetting a demand decline of 10 MMbbl/d in developing economies.

The IEA projects global oil demand from trucking will grow by 3.9 MMbbl/d, while global oil demand from petrochemicals grows by 4.8 MMbbl/d.

At the same time, the IEA expects oil use in cars will peak in the mid-2020s. It projects approximately 300 million cars on the road by 2040 will avoid 3.3 MMbbl/d of oil demand that year, while efficiency improvements in nonelectric cars will avoid more than 9 MMbbl/d of oil demand in 2040.

The IEA projects automotive demand for oil will decline by 5 MMbbl/d from 2017 to 2040 in advanced economies, offsetting demand growth of 5.4 MMbbl/d in developing economies.



Permian producers prepared for dip in oil prices to last into 2019

Mindful of the lessons learned during the 2014-2016 oil and gas price collapse, large independent producers in the Permian Basin are shielded from the current U.S. oil price slide, thanks to conservative budgeting, new access to Brent crude pricing at the Houston Ship Channel and greater efficiency.

The price of West Texas Intermediate crude oil bounced back above $60 per barrel on the morning of Nov. 12, a slight improvement over the end of the previous week but still well below the $76.40/bbl reached in early October. If prices remain near $60/bbl, that will be more than enough for most producers to see healthy returns, as many have budgeted for prices at $50/bbl or below. Even though prices spiked more than $20/bbl above anticipated levels for several months, Permian producers largely made only slight increases to budgets as they looked to the long term.

"The industry has been conservative in oil price assumptions," Williams Capital Group LP analyst Gabriele Sorbara said. "I would say a majority of 2018/2019 budgets are contemplated on $50-$60/bbl WTI."

EOG Resources Inc., one of the largest producers in the region, assembled a capital budget for 2018 assuming oil prices at $40/bbl and gas prices at $2.50/Mcf, and the company intends to take a similar approach in 2019.

"We're not going to increase capital at the expense of efficiencies and returns. We will develop our assets and spend capital at a pace that will optimize our learning curve and allow sustainable improvement to our well productivity and cost structure," EOG CEO William Thomas said. "Any production growth is strictly the result of disciplined capital allocation to high-return assets. … We are continuously resetting the company to deliver strong returns, even in a low to moderate oil price environment."

When capital budgets for 2018 were assembled, most Permian producers assumed that WTI would hover around the $50/bbl level for much of the year. Even though they recognized far more revenue during the second and third quarters than initially anticipated, they seem content to stay the course at similar levels for 2019.

"What matters for companies is the long-term expectation," said Raymond James & Associates analyst Pavel Molchanov, who anticipates that most companies will continue to build budgets based on prices near $50/bbl. "The futures pricing for 2019 is pretty close to what it was a year ago."

Unlike the situation facing Permian producers during much of the price collapse, many independents have a new advantage, in spite of pipeline constraints: exports to Europe and Asia through the Houston Ship Channel. The exposure to offshore markets and Brent crude prices has allowed them to increase their revenues, as Brent crude was trading at more than $71/bbl on Nov. 12.

Pioneer Natural Resources Co. CEO Timothy Dove said during the third-quarter earnings call that his company would stick to its $3.4 billion budget for 2018 and is likely to take a similar course in 2019. But Dove said Pioneer is now able to avoid the consequences of a WTI price drop due to large amounts of its Permian crude being exported.

"We are now essentially a Brent-priced company if you talk about our oil sales," he said.

Another lesson learned from the price collapse was a continued push for efficiency, with producers using new technologies and methods to cut costs while increasing production. During Anadarko Petroleum Corp.'s third-quarter earnings call, executives said the company's more efficient operations would allow it to recognize "double-digit" production growth while maintaining a budget anticipating $50/bbl prices.

Apache Corp., which is increasing its Permian operations with the development of the Alpine High play, said it would operate in 2019 with a capital budget of $3 billion, lower than in 2018. "If changes in expected cash flow dictate, we have the flexibility to reduce our activity levels accordingly," CEO John Christmann said. The move by Apache and other producers to follow long-term price expectations and not become overly exuberant over higher prices earlier this year may have allowed companies to hold steady heading into 2019.

"Capital spending should be either stable from what it is this year or modestly higher, but no one should expect cuts in capital spending from recent levels because this year's capital programs always lagged behind the uplift we saw in prices we saw in the summer months," Molchanov said.



Stocks Rocked the House Post Midterm Elections

After the S&P 500 logged its 9th worst Oct. on record, losing 6.9%, it has bounced back 2.6% month-to-date through Nov. 9, 2018. Though the monthly returns for the eight Novembers following the historically bad Octobers were only positive twice – in 1978 (President Jimmy Carter midterm year) and 1933 – the fact there was a midterm election this year may help the chance of a solid rally if history repeats itself. Historically, the S&P 500 has been positive in most periods after the midterm elections.

In the months of Nov. and Dec. during historical midterm election years, the S&P 500 gained 14 of 22 times in Nov. and in 15 of 22 times in Dec. with a combined 2-month gain in 17 of the 22 midterm election year-ends. In percentage terms, the S&P 500 gained in 64% of midterm election Nov. months and 68% of the following month that when combined into a 2-month return resulted in gains 77% of the time. Also, the magnitude of the average gains in the 2-month period was 6.1%, more than the magnitude of the average loss of 4.1%.