Given the cyclical nature of the sector (especially in recent years), many investors unfortunately tend to view energy, and most commodities, as simply a trade, not an investment. It is under this backdrop that we are highly encouraged by a landmark shift that seems to be occurring in the sector regarding capital discipline at numerous US oil producers. Last September, Anadarko Corporation (APC) announced its plans to use cash on hand to repurchase up to 10% of its shares, instead of plowing those funds back into development expenditures or making an expensive acquisition. (See our Sept 22, 2017 blog “Could APC’s Share Buyback Signal an Energy Inflection Point?”) The news was welcomed by Wall Street, sending APC shares up 8% on the day, and was viewed as an indication of prudent capital allocation and a willingness to listen to the wishes of shareholders.
At that time, we hoped the Anadarko announcement could serve as a needed shift in the financial strategies of E&P (exploration and production) management teams. Fortunately, we have been positively surprised by the extent at which other producers have adopted this capital discipline approach and, most importantly, appear to be holding to this rhetoric even as oil prices have risen. Last week, we attended a major sellside-hosted investment conference, where many US oil producers participated in panels concerning key energy topics. On several occasions, producers were asked point blank if they expected to change their production plans for 2018 given the most recent spike in crude prices. Naturally, the management teams were somewhat guarded in conveying precise expectations ahead of upcoming 4Q17 reporting. Still, essentially unanimously the management teams responded that they had no intention of changing their upcoming production plans, which in most cases were based on considerably lower oil prices (e.g., $50/barrel for WTI). Moreover, they said they would look to allocate added cash flows from higher oil prices to reducing debt levels or to shareholder return measures (dividends or share buy-backs), instead of boosting capital expenditures on new projects.
Of course, this is the answer the audience wanted to hear, and ultimately the proof will be in the pudding when the companies report production and free cash flow in upcoming periods. Still, we believe this newfound shareholder-friendly focus presents the opportunity for the sector to be viewed in an entirely new light. Rather than an endless chase for production growth from developing new wells and outspending cash flows, a broadly-shared mentality of growth within cash flows, as well as the harvesting and return of excess cash flows to shareholders, is an approach that we believe will attract longer-term investors to the sector.
Therefore, as we approach 4Q earnings season, we expect comments from E&P management teams on conference calls to further reflect this new tone of capital discipline. Such comments began to be made last quarter on the 3Q conference calls (see below). Still, with the recent uplift in oil prices attracting greater focus on the sector (aided by rapidly-falling crude inventories and enhanced political risks), we believe a reiteration of capital discipline comments by producers could further enhance investor attention and support our view that energy is not simply a trade.
Quotes on 3Q Conference Calls Regarding Capital Discipline by Management of Various E&Ps
Source: Company 3rd Quarter 2017 conference calls
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