In Part I of our Themes from Q2 Earnings, an overarching narrative was an oil and gas industry reaching a relatively steady operational state, with efficiencies offsetting cost inflation and helping lead to growth in free cash flow despite the tumultuous past 18 to 24 months.  These factors allowed most E&P operators to deleverage, and in some cases, also resume or increase their return of capital (either via dividends or share buybacks) to shareholders.  In the latest earnings calls, these themes continue as the primary focus as we head towards year-end 2021.  Some of the talking points in the Q3 earnings calls continue on the same trajectory as in Q2, such as maintaining capital discipline with flat or low growth in production volumes.  However, there was more variance in the latest round of calls regarding E&P operators’ possible approaches to fortify their value proposition to shareholders.

Natural Gas Exports

As noted in our recent blog post regarding natural gas prices and production levels, demand for U.S. LNG exports from European and Asian (primarily China) markets have resulted in elevated prices for natural gas despite the relatively high level of gas production coming from U.S. basins.  This particular topic came up in several of the Q3 calls.

• “We’ve talked in the past about the nearly 550,000 barrel a day increase in petchem demand in China from 2021 to 2023 and over 110,000 barrels a day of European and North American PDH growth during that same time period.  What many did not anticipate was the global pressure for hydrocarbons this fall and winter that resulted in elevated LNG prices in Europe and Asia.  This is driving additional demand for LPG in these markets through its use in industrial heating and power applications in lieu of today’s high cost of natural gas.  On a BTU equivalent basis, LPG is nearly half the price of LNG delivered in the Far East markets.  The impact from this incremental demand for LPG is a widening export arb.” – David Cannelongo, Vice President of Liquids Marketing & Transportation, Antero Resources

• “We’re going to continue to look at new opportunities from an LNG standpoint and are very well-positioned.  Again, it gets back to our transport, our export capacities, and just having that ability to transact, we can definitely be very nimble as we think about new opportunities.” – Lance Terveen, Senior Vice President – Marketing, EOG Resources

Many Paths to the Value Proposition

Perhaps the most significant divergence in the Q3 E&P operator calls compared to the Q2 calls stemmed from how the management teams viewed their value proposition to shareholders.  Global energy prices were shaken in early 2020 with the onset of the COVID-19 pandemic, with prices retreating further when the discussions regarding renewal of the OPEC+ production/price cooperation pact, a 3-year plan that was set to expire at the end of Q1 2021, fell apart as Moscow refused to support Riyadh’s demand for additional production cuts.  As energy prices recovered amid a background of heightened uncertainty in the global economic and financial markets, E&P operators tightened their belts and took this opportunity to enact highly disciplined capital programs in order to extract greater free cash flow from flat production levels.

For some companies, the value proposition to shareholders remains focused on either increasing the intrinsic value per share via share repurchases or returns to shareholders through dividend programs.

• “As we continue to trade at a material discount to our intrinsic per share value as we see it, we steadily increased our attention on share count reduction.  And Q3 was a good example of this.  Approximately 60% of free cash flow was returned to shareholders in the form of buybacks.  We continue to see a significant opportunity to retire additional shares in what we believe to be currently attractive prices.  And as a result, on October 25, earlier this week, the Board has increased our share repurchase authorization by $1 billion, now having a sizable share repurchase authorization at our disposal.” – Nicholas Deluliis, President & CEO, CNX Resources
•  “I don’t want to get ahead of my Board, but I would say at Murphy, we’re more tuned to dividend and getting our dividend back. We’re a dividend payer for 60 years.  And that would be best for us.  And, of course, a variable dividend, I suppose, can come into that mix. And I would say at this share count, that would be the basis today.” – David Looney, CFO, Murphy Oil

For other E&P operators, the name of the game moving forward is flexibility to deliver returns to shareholders through share repurchases and dividend programs.

• “In mid-September, our Board approved a $2 billion share repurchase program.  After that announcement, we repurchased over 268,000 shares at an average share price of $82 for a total cost of $22 million in the third quarter.  If we do not repurchase enough shares in the quarter to equal at least 50% of free cash flow for that particular quarter, then we will make our investors whole by distributing the rest of that free cash flow via a variable dividend.  This strategy gives us the ability to be flexible and opportunistic when distributing capital above and beyond our base dividend, but importantly, at least 50% of free cash flow will be returned.” – Travis Stice, CEO, Diamondback Energy

Perhaps most interestingly, a handful of companies cited additional sources of future shareholder value, setting their sights on opportunities to be had out in the field, be it through acquisition activity or plans to enhance their exploration program.

• [Regarding the November 3^rd announcement of Continental Resources’s agreement to purchase Delaware basin assets from Pioneer Natural Resources] “We focus every day on maximizing both shareholder and corporate returns. The Permian Basin acquisition will be an integral contributor to these shareholder return plans.  Possibly most importantly, this Permian transaction is projected to add up to 2% to our return on capital employed annually over the next five years.  The acquisition of these assets strongly supports the tenants of Continental’s shareholder return on investment and return of investment, dividends and share repurchases.” – William Berry, CEO, Continental Resources

• “After weathering two downturns during which we did not cut nor suspend the dividend, the new annual rate of $3 per share reflects the significant improvement in EOG’s capital efficiency since the transition to premium drilling.  Going forward, we are confident in our ability to continue adding to our double-premium inventory without any need for expensive M&A by improving our existing assets and adding new plays from our deep pipeline of organic exploration prospects, developing high-return, low-cost reserves that meet our stringent double premium hurdle rate, expands our future free cash flow potential and supports EOG’s commitment to sustainably growing our regular dividend.” – Ezra Yacob, CEO, EOG Resources

Conclusion

Mercer Capital has its finger on the pulse of the E&P operator space.  As the oil and gas industry evolves through these pivotal times, we take a holistic perspective to bring you thoughtful analysis and commentary regarding the full hydrocarbon stream.  For more targeted energy sector analysis to meet your valuation needs, please contact the Mercer Capital Oil & Gas Team for further assistance.