Energy

North American Oil Drillers' Shareholder-Friendly Antics Making Deleveraging Harder


A cursory glance at North American oil exploration and production (E&P) companies’ financial leverage would suggest the situation has improved substantially since the 2014-16 crude market price slump. Within that landscape, majority of U.S. shale oil producers have also in the main reduced their long-term debt by paying down obligations which will soon reach maturity, in tune with their own deleveraging goals.

However, with equity investors demanding better returns, sub-$60 per barrel West Texas Intermediate prices and headline growth worries, the credit quality of the players is likely to weaken and their ability to stick to deleveraging targets will be severely tested, according to industry research.

In a recent note to clients, Moody’s warned that many E&P companies are succumbing to the risk of share buybacks, particularly with shareholder activism on the rise.

Workers connect drill bits and drill collars at an oil exploration site in the Permian basin outside of Midland, Texas, U.S. (Photo: Brittany Sowacke/Bloomberg)

© 2014 Bloomberg Finance LP

“Further deleveraging will be difficult through to 2020. The deleveraging seen in the past few years has been primarily due to rising cash flow while debt reduction has only been modest. At the same time, efforts to boost capital efficiency are set to stall over the next couple of years, while share buybacks threaten to offset rising cash flow,” the rating agency noted.

While there is volatility in the commodities market, oil futures have also settled into a modest price band for the “foreseeable future”, making further deleveraging even more doubtful given the prospect of little to no earnings growth and higher shareholder distributions.

That said, Moody’s acknowledged that North American drillers’ balance sheets are in a far better shape today than in 2015-16, following the agency’s examination of the financials of its 40 largest rated independent E&P companies and including those firms’ key credit metrics since 2013, prior to the price slump that started in July 2014.

Overall, neither range-bound commodity prices nor the lack of further cost structure improvement opportunities bode well for further enhancement in E&P firms’ capital efficiency during 2019-20.

“Although lower production costs since 2015-16 have largely stuck, in the past two years they have ticked up, by 6%-7% annually. While drilling and completion costs have eased somewhat in 2019, labor, steel and land acquisition costs are still on the rise,” said Sajjad Alam, Senior Analyst at Moody’s.

There are also cash flow ‘have(s)’ and have not(s)’ spread across North American drilling acreages, and Moody’s said those drillers with capital discipline who finally have free cash flow, are increasingly sending it shareholders way in the form of higher dividends and share repurchases instead of their following the previous sentiment of reinvesting in the business.

That’s despite companies’ still relatively large debt balances. Meanwhile, there are plenty of those with cash flow headaches too, especially at the lower end of the corporate valuation chain. Rystad Energy’s recent research found only 10% of its examined sample of 40 mainly U.S. shale oil companies with a positive cash flow balance in the first quarter of 2019, bringing down the share of companies with a positive cash flow balance from the recent norm of around 20%.

Total cash flow from operating activities (CFO) fell from $14 billion in the fourth quarter of 2018 to $9.9 billion in the first quarter of 2019.

That is the lowest CFO Rystad has noted since the fourth quarter of 2017, said Alisa Lukash, Senior Analyst on Rystad Energy’s North American Shale team. “The gap between capex and CFO has reached a staggering $4.7 billion (of our examined sample). This implies tremendous overspend, the likes of which have not been seen since the third quarter of 2017.”

Anecdotal evidence from Houston, America’s oil and gas capital, suggests few of the more indebted operators are sniffing the possibilities of issuing bonds – eyeing an interest rate cut by the U.S. Federal Reserve this year – to partly cover outstanding obligations for 2020, but there hasn’t been an initial public offering since 2014 before oil price tanked.

All of this forms part of the wider North American picture that has seen stakeholders, financiers and investors put E&P companies under extreme pressure, according to Deborah Byers, Americas Sector and Solutions Leader, and U.S. Oil and Gas Leader at EY.

“They are leaving no room for undisciplined spending in 2019, and in many ways the industry would be better for it via more optimized and less wasteful operations.”

That might well be true, but the ongoing shareholder friendly-antics do indicate that deleveraging will not be top of the E&P companies’ agenda this year, assuming no dramatic and sudden uptick or downside either side of the $50-70 per barrel range.



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