We read on a regular basis in mainstream media that shale companies spend more money than they bring in, and that investors are growing tired of pumping money into companies without a return on their investment. We’ve recently noticed a renewed commitment on the part of major drillers to get their financial houses in order–spend less and drill less in order to make more money. We spotted an article by Reuters on the “shale drillers aren’t profitable/healthy” meme which got us investigating the financial health (or lack thereof) for Marcellus/Utica drillers. What we found may interest you.
The drumbeat in the media is that shale drillers, not just in the Marcellus/Utica but in other plays (like the Permian), are not living within their means. That is, they consistently spend more each year on new drilling than they bring in via revenue from existing production. The difference must be made up from investors, bankers, or floating new securities, like bonds (i.e. debt) or shares of stock (equity). Any way you slice it, sooner or later investors will punish companies that can’t turn a profit–by not investing.
The main barometer for the financial health of a company is its stock price. Companies don’t get revenue from their stock price–unless they issue new shares–but they watch the per share price closely because (a) the folks who own those shares ultimately determine the direction of the company by electing a board, which in turns appoints top management, and (b) because the overall value of the company, its “market capitalization,” is determined by the share price.
In a simplified example, if a company has 1 million shares of outstanding stock, and the average per-share price is currently trading at $20 per share, the market cap of the company is 1 million x $20 = $20 million. If the price per share sinks to $10 per share, the company’s market cap or “worth” sinks to $10 million. So how does that affect the company? Banks are willing to lend twice as much money to a company worth $20 million as one worth $10 million–because there’s more collateral to back it up. And the $20 million company can borrow at a cheaper interest rate than the less valuable company. It’s less risky for the lender. You get the idea.
We spotted the following article on Reuters:
U.S. shale producers last year again spent more money than they collected, extending a years-long streak of putting oil output above cash flow and investor returns, according to a Reuters analysis of top independent producers.
All but seven of 29 of these producers last year spent more on drilling and shareholder payouts than they generated through operations, according to securities filings. Total overspending by the group was $6.69 billion in 2018, according to Morningstar data provided to Reuters by the Sightline Institute and the Institute for Energy Economics and Financial Analysis.
While total overspending was down slightly from a year earlier, stock prices in the sector have slid at a time when U.S. share prices in general have posted strong gains.
Shale firms are pushing U.S. oil output to record-shattering levels, but companies have prioritized spending on acreage and drilling. The data showed few producers generated solid returns, even as U.S. crude prices rose 28 percent in 2018 to an average $65.06 a barrel, from $50.79 in 2017.
Stock prices of all 29 shale producers fell in 2018, pressured by volatile crude prices and stronger returns in other sectors. Only one of the 29, Cabot Oil & Gas Corp, traded higher at the end of 2018 than it did two years earlier.
For too many shale firms, generating more cash than they spend is “aspirational,” said Lee Tillman, chief executive officer of Marathon Oil Corp. “We’ve got to develop the trust and credibility that we are going to prioritize the shareholder going forward, that this really is a maturing of the shale business over time,” Tillman said.
An investor who put $100 into the S&P 500 Oil & Gas Exploration & Production Index in 2013 would have had $58.99 at the end of 2018. Similar $100 investments were worth just $9 in Whiting Petroleum Corp, $33.51 in Apache and $38.88 in Devon, according to financial filings. By contrast, $100 in the S&P 500 grew to $150.33 over the same period.
“This is a critical moment” for shale producers, said Clark Williams-Derry, director of energy finance at think tank Sightline Institute. “They’ve lost the confidence of the investors.”
OIL SHARES LOSE LUSTER
Data showed just a few companies collected more than they spent in 2018, including Marathon Oil, EOG Resources and Continental Resources Inc. Outspenders such as Apache, Carrizo Oil & Gas, Devon Energy, Noble Energy and Diamondback were the majority.
So many investors have cut oil and gas holdings, the energy industry’s weighting in the S&P 500 index of large publicly traded U.S. companies fell to 5 percent this year from 11 percent in 2012.
“I believe the generalist investor returns to the E&P (exploration and production) space but it’s a matter of them having comfort not just with the commodity but with the behavior of management teams,” Anadarko Petroleum Corp President Bob Gwin said in an interview.
The shale revolution made stars of independents, which were able to drill and achieve initial production without the years-long investment required of conventional wells. But output from shale wells falls sharply after the first few years, requiring companies to keep drilling.
Some investors believe a shakeout is coming that will separate cash burners from shale companies that can produce more with less investment.
“These exploration and production companies are becoming essentially production companies,” said Dimitry Dayen, an analyst at ClearBridge Investments, whose holdings include Anadarko and Pioneer Natural Resources. “The focus is on capital efficiency,” by cutting spending to a level that allows more cash from stable production.
Using asset sales to fund stock buybacks is no longer enough to please investors, said Tarigh Yusufi, analyst with Steadfast Capital Management, at the CERAWeek conference in March. Companies “need to demonstrate that the asset base can convert into free cash flow,” Yusufi said.
BACKLOG OF DEALS
Ben Dell, managing partner at Kimmeridge Energy Management, which has launched activist campaigns against shale firms, believes more than half of U.S. producers must disappear through mergers or sales.
But poor returns and volatile crude prices have slowed deal talks, and also soured investor interest in energy initial public offerings.
“There’s a big backlog of assets people would like to sell,” said Andrew Dittmar, a mergers and acquisition analyst with research firm Drillinginfo. Deals came to a halt when oil prices dropped about $30 per barrel last fall, and have not fully recovered. “It’s hard to say what gets deals moving again,” Dittmar said.
Anadarko and Noble Energy were among the shale firms that used proceeds from asset sales last year to repurchase stock – a popular move with investors.
But many shale operators remain on the sidelines as investors insist that anything they buy must already be generating significant cash flows, said Gregory Beard, head of natural resources at private equity firm Apollo Global Management.
EP Energy, a shale producer that spent $245 million last year to acquire South Texas acreage, recently warned of a default if it cannot get additional financing or oil prices do not rise.
“The time when they are given the benefit of the doubt is over,” said Beard.*
*Reuters (Apr 2, 2019) – Cash flow still weak at U.S. shale firms, stock prices underperform
That was an interesting point about Cabot Oil & Gas, that their share price is the only one of the big drillers trading at a higher price point than two years ago. That got us to wondering, how does the per-share price look for other major drillers in the Marcellus/Utica? Can we use the share price as a barometer for the overall health of these companies? If we do, the results are not encouraging.
We selected seven of the biggest M-U drillers, the top drillers in PA, OH and WV, comparing their stock price performance over the past five years. Bear in mind these are all publicly traded companies. We are not showing privately-held companies. We arranged them alphabetically.
Well, yeah, it’s not a pretty picture, is it? Cabot is the only one in the bunch halfway decent, and even Cabot’s stock performance is not great. If we use share price as the barometer of financial health, perhaps there is reason for concern.
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