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Moody's: E&P executive pay incentives too focused on production growth

If an executive with a North American exploration and productioncompany wants to get their annual bonus, they'll keep pumping oil and gas, Moody'ssaid in a new report.

Moody's said the executive agreements of the largest producersin the U.S. and Canada show that there is financial incentive to increase production,but very few have arrangements for bonuses to be paid out for keeping debt in checkdespite the downturn.

The ratings firm said that production and reserves growth targetsstill made up "almost a quarter" of senior executive target bonuses in2015, in spite of the oil and gas price crash. That made it the most prevalent metricin terms of incentives, ahead of expense management and strategy.

"Given our pessimistic industry outlook, this system ofcompensation is negative for credit investors and suggests that many E&P companiesare finding it difficult to shed their high-growth strategies," said ChristianPlath, a vice president and senior credit officer at Moody's.

Only four of the 15 companies Moody's reviewed included debtreduction as one of the financial incentive goals for their executives, led by linking15% of its target bonus allocation for CEO Scott Sheffield and other company leadersto debt cutting efforts.

On the other hand, independents with significant balance sheetissues continued to push production strongly: it made up 40% of bonus targets forChesapeake Energy Corp.executives and 50% of the targets at AnadarkoPetroleum Corp..

A good portion of the reasons companies continue to emphasizeproduction over all other factors is the belief that increased oil and gas productiontotals will lead to higher stock prices. That, Moody's said, remains a driving focusfor nearly every producer, even when cost-cutting measures would be the better playfor the long term.

"Fourteen of the companies that Moody's evaluated use performanceaward plans linked to relative total shareholder return. This strong and directfocus on share prices raises certain credit risks by rewarding aggressive sharerepurchases and the maintenance of dividends even when cutbacks would be prudent,"the ratings agency said.

"The focus on shareholder returns also reflects the E&Pcompanies' high-growth mindset, and may motivate boards and managers to focus ongrowth over preserving value," Moody's said. "Nearly all of the awardsare in some way linked to share-price appreciation. While large companies generallytry to tie long-term pay closely to share-price performance, the link appears strongerin the E&P sector."