Energy Valuation Insights Themes from Q2 2020 Earnings Calls
Part 2: E&P Operators
As discussed in our quarterly E&P newsletter, the oil & gas industry experienced a volatile path to price stability as COVID-19 and the Saudi-Russia price war took a toll on supply and demand. The road to recovery was apparent late in the quarter and was driven by supply cuts from OPEC+, curtailments by U.S. producers, and an increase in demand. In this post, we capture the key takeaways from E&P operator second quarter 2020 earnings calls.
Theme 1: Cost Reductions Expected to Persist
One recurring theme among E&P operators in our prior E&P operator earnings calls quarterly overview included a continued focus on capital discipline. The six E&P operators we track typically characterize this concept as the reduction of operational costs and capital expenditures in the pursuit of increased operational and capital efficiencies. To that effect, all six operators pursued this goal in the second quarter, with most indicating the expectation that a substantial portion of these cost reductions will persist beyond the current environment of suppressed crude oil prices and uncertain projected economic activity.
- We expect capital efficiencies to increase across both the Bakken and the South in 2020. In the Bakken, we have achieved a 12% reduction to completed well costs. In the South, we’ve achieved a 10% reduction to our overall South completed well cost. 70% of these reductions are structural in the Bakken, and 80% of these reductions are structural in the South, driven by all aspects of our operations. – William Berry, CEO, Continental Resources, Inc.
- This flexibility, combined with mature production base and the structural well cost savings we have delivered, underpins our outlook for durable cash flow generation, as we were able to reduce our reinvestment rate, while maintaining production levels in a low-price environment. – Joseph Gatto, President & CEO, Callon Petroleum Company
- Diamondback has further adjusted downward our already low-cost structure and is prepared to operate successfully in a lower-for-longer oil price environment. A lot of the efficiency and cost gains made during this downturn will become permanent and will benefit Diamondback shareholders in a recovery. – Travis Stice, CEO, Diamondback Energy, Inc.
- When you look at these efficiency gains combined with service cost deflation and a consistent development strategy, we continue to drive down our well costs and drastically improve capital efficiency. As you can see […] we have reduced our well cost by approximately $1.8 million or 20% in the first two quarters of 2020. We believe that approximately 60% of these cost reductions are sustainable. – Joey Hall, Executive Vice President – Permian Operations, Pioneer Natural Resources Company
Theme 2: Emphasis on Free Cash Flow to Reduce Debt and Reinforce Dividends
In our prior quarterly analysis, we noted that the operators seemed inclined to comment on their priorities moving forward. This was a recurring theme in the Q2 earnings calls. Short of referring to any such commentary as official guidance, most operators still discussed three to five year strategic goals, driven primarily by the growth of free cash flow projected to result from the cost reductions outlined previously. Among the priorities set forth by the operators, the two primary goals cited included debt reduction and providing for attractive dividends to shareholders.
- As I think about the first half of this year, we’ve made real progress on several priorities that will position us for the future: maximizing our cash flow by adjusting our spend rate, production and cost structure; increasing the strength of our balance sheet; continuing to return capital to shareholders through our dividend; and managing the oil price volatility with capital discipline, while also preserving our operational capacity. – Tim Leach, Chairman & CEO, Concho Resources Inc.
- With our reduction in forward capital spending, and expectation for true free cash flow generation at current commodity prices in the second half of 2020 and 2021, we will look to reduce both gross and net debt while continuing to return capital to our shareholders through our base dividend. – Travis Stice, CEO, Diamondback Energy, Inc.
- Initially we’d be looking to prioritize a bit of debt reduction as we then look to ease back into a base dividend structure. And then, in excess of that, there are a lot of other vehicles that we could consider the variable dividend is one, but certainly even share repurchases is another. I mean, nothing would be off the table. – Lee Tillman, President & CEO, Marathon Oil Company
Theme 3: Expectation of Little to No Production Growth… Mostly
Remarkably, the pursuit of production growth was not presented as an immediate priority by most operators at this time.
- We were saying essentially that – and early on – that we should not be, as an industry, overproducing into an oversupplied market. – William Berry, CEO, Continental Resources, Inc.
- Certainly, we’re not seeing any signals that growth is needed from Diamondback or from our industry in general. So, growth in today’s world is pretty much off the table. – Travis Stice, CEO, Diamondback Energy, Inc.
- Today, the world simply does not need more of our product. – Lee Tillman, President & CEO, Marathon Oil Company
The exception was Pioneer Natural Resources, which was the only operator that specifically cited a positive production growth rate estimate:
- We say 5% plus on production growth, some years it maybe 6%, some years it maybe 7%, but we don’t want to just tie to one number based on rig activity, DUC activity, frac fleet activity. We can’t hit 5% every year, so we want the flexibility, some years it maybe 7%, 8%, some years it maybe 4%, some years it maybe 5%, and so we’re just saying 5% plus on production growth over the next several years. – Scott Sheffield, CEO, Pioneer Natural Resources Company
On the Horizon
The E&P operator earnings calls broadly paint the picture of a mature industry in uncertain times. The name of the game at this juncture is to shore up the balance sheet, increase efficiencies through capital discipline, and signal resilience by way of free cash flow growth and reinforced dividends to shareholders.
However, as these companies stand relatively still as they fortify their positions for sustaining operations over the long-haul, changes and evolution are on the horizon. Most prominently, the U.S. presidential election looms around the corner. There is no indication of a consensus among the E&P operators regarding the likelihood of a regime change, or what changes would likely affect the industry if faced with a Democratic Biden administration.
It should also be noted that the majority of the E&P operators have forthcoming formal ESG reports, with most slated to come out later this year. We expect these topics will be featured in our next quarterly review of the E&P operator earnings calls.
