Billion-dollar share buyback plans Devon Energy Corp. and Hess Corp. recently unveiled show that shale oil and gas companies know they are being evaluated under new rules that look beyond the traditional metrics of production and reserve growth, according to industry analysts. They said investors want to see some yield through dividend payments and share buybacks.
For the past year, Wall Street analysts have punished independent exploration and production companies that spent capital to grow production volumes. Instead of grading on production growth, analysts have drawn a narrower corridor for success: grow production with better technology while returning spare cash to shareholders.
The message seems to be: Stop being a dot-com and start being a factory. Investors are beyond land grabs and now expect monster wells that pay a profit.
"The (return of capital) horse is out of the barn," analysts at energy investment bank Tudor Pickering Holt & Co. said. "The Devon Energy sale of its [Barnett Shale] asset, share repurchase authorization and dividend boost illustrate: 1) mounting evidence that E&Ps are actually serious about improving cash returns to shareholders; and 2) interest of private capital in acquiring acreage positions which are no longer core within the portfolios of publicly traded E&P operators."
While the first companies to shift gears were the Appalachian shale gas drillers such as Cabot Oil & Gas Corp. and Gulfport Energy Corp., the Hess and Devon announcements show the trend spreading to the shale oil drillers. "Beta is dead," Guggenheim oil and gas analyst Subash Chandra said Feb. 26. "There may be no durable reward for financial or operating leverage in any price environment. Rewarding companies for 'real estate' rather than execution is likely over as well."
Chandra said gas companies were first to pivot, given the maturity of the shale gas industry and the oversupply outlook. "But most of the announcements this quarter were from oil companies."
After a two-day trip to Houston to meet with E&Ps, Wolfe Research LLC analyst Josh Silverstein came away thinking that paying back shareholders is a trend with some legs. "Key from these meetings though was that 2018 cash returns will continue into 2019 and beyond at some level (% of CFO driven) even without asset divestiture proceeds," Silverstein said March 7 before the Hess and Devon announcements.
Silverstein said Newfield Exploration Co. is thinking about shareholder return, as it expects free cash flow growth in 2019. Oasis Petroleum Inc. and Apache Corp. are thinking about balancing growth and development plans with cash returns. "It may take six more months for investors to gain further confidence, but this is a sustainable positive trend for E&Ps."
The companies that do not return free cash flow to shareholders will need to be leaders in low-cost development and have the best balance sheets, the analysts said.
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One dynamic of the return to shareholders criteria will be to pressure oil supermajors to change capital spending plans as well as attract investors to independent E&P's for their yield, not for growth momentum, Tudor Pickering Holt analysts said.
"The quintessential integrated oil and gas asset portfolio manager, [Exxon Mobil Corp.], is stepping up its pace of capital investments into the first half of the next decade," Tudor Pickering Holt said. "Will be interesting to see whether this capital allocation dichotomy sparks some capital rotation (by public equity investors) out of the oil majors into the newly disciplined independents as this year unfolds."
Yield investors want simplicity and stability, and so the larger independent oil and gas companies will have to establish a track record to replace the major oil and gas companies that have been the traditional focus for that class of buyer. Still, their growth profile and cost advantages may prove tempting, Chandra said.
"The playbook then is to focus on core basins, sell non-core assets and preferably shift to liquids from dry gas," Chandra wrote, describing the model for an attractive E&P investment and highlighting operators in Texas' Delaware Basin.
Not all companies are on board with the trend. EOG Resources Inc. is sticking to the old-school philosophy and plans to use free cash to invest in high-return projects, Jefferies LLC oil and gas analyst Mark Lear said. "EOG wants to continue to drive [return on capital employed] higher, not only to a peer-leading level, but to a level comparable to the returns in other industries."

