Oil and gas drillers in the U.S. shales have to stop rewarding volume growth and start focusing on returning cash to shareholders in a shift to a manufacturing model that values cash flow more highly, industry experts said at a Feb. 27 conference in Washington, D.C.
If stock prices are an accurate reflection of how the market views the future, and Wolfe Research Managing Director Paul Sankey thinks the market is rarely wrong, the outlook for shale oil and gas producers is almost terminal unless they change their model from one predicated on historical shortages of resources to a new shale-driven environment where resources are unlimited for all practical purposes.
The year 2017 "marked the death of 'prices will be higher in the future,'" Sankey said at the Center for Strategic & International Studies' "Short-Term Outlook for U.S. Tight Oil Production," as oil and gas stocks lost money while commodity prices, primarily for oil, improved. "There are no resource limitations."
Sankey said oil and gas executives should brace themselves for a shareholder pushback on the structure of their pay packages to stop rewarding production growth. Today's exploration and production company needs to change its business model to one that returns 10% to shareholders through buybacks and dividends, Sankey said.
At $60-per-barrel oil prices, "everything works," said Jan Stuart, global energy economist at the investment firm Cornerstone Macro LLC. Shale "is not making money yet, but we are this close," Stuart said. On the other hand, Stuart's presentation asked, "If shale is a great business, why don't investors call?"
Patient investors will soon be rewarded, Stuart said, as balance sheets have been fixed. The reward is not across the board for the sector but instead limited to Permian Basin shale oil drillers, leaving Appalachia's shale gas drillers out in the cold.
"Gas is not great," Stuart said, with shale gas drillers in the bottom fifth of his performance charts, which were led by shale oil drillers such as Parsley Energy Inc., EOG Resources Inc. and Pioneer Natural Resources Co.
"It's funny that the financial sector is asking the oil sector for discipline," IHS Markit Financial Services Vice President Roger Diwan said. "None of them are very disciplined."
"The rocket fuel of the U.S. shale system" has been cheap capital over the past decade, Diwan said, and lenders encouraged producers with every dollar they generated and every dollar they could borrow. "Now we are telling them to drill with the dollars they have."
Despite the shift in attitude, Diwan said, there are still plenty of lenders out there willing to finance oil and gas drilling, as well as infrastructure and midstream projects. "In no industry [except oil and gas] can you build a plant in 120 days and immediately produce cash flow," Diwan said.