Themes From Q4 Earnings Calls

Part 1: E&P Operators

Special Topics Valuation Issues

In Part I of our Themes from Q3 Earnings, topics included increased global demand for U.S. LNG exports and the divergence in the value proposition of E&P operators. Some opted to focus on using free cash flow to either pursue share repurchase programs and/or increase dividends instead of seeking out acquisition opportunities.

On the other end of the spectrum, Continental Resources announced an agreement to purchase Delaware basin assets from Pioneer Resources to the tune of $3.25 billion. Technically, this acquisition was announced in Q4 (on November 3rd), but Continental’s management team made a point of mentioning it in the Q3 earnings call. Still, some companies, like EOG Resources, signaled setting their sights on pursuing more organic, exploration-driven growth and footprint expansion.

In the last round of earnings calls for 2021, cost inflation was discussed with a bit more granularity than in recent quarterly calls, strengthening oil prices sparked a shift in focus towards the liquid hydrocarbon streams, and commentary regarding macro policies targeting hydrocarbons were prevalent in E&P management discussions.

Cost Inflation

In our Q1-Q3 2021 Themes From Oilfield Service Company Earnings Calls post from late January, we noted that OFS operators were likely hitting an inflection point in mid- to late-2021, with greater command of the prices they charged their E&P customers than in recent history. While service cost inflation was certainly on the minds of some E&P operators, costs for various industry inputs were mentioned in the Q4 earnings calls.

  • “On the service side, on the rig and the frac crew side, because the way that we’ve contracted those services we’ve been somewhat isolated so far, in any kind of cost inflation along those lines. Where we’ve seen the bulk of the inflation so far in our business has been materials, particularly with respect to steel related material. Probably half of the inflation that we’ve baked into our ’22 forecast [5% to 10%, year over year] is almost entirely in either steel or tubular. The rest of it, would it be spread across the multitude of materials that we use in our business.” – Chad Griffith, Chief Operating Officer, CNX Resources
  • “Our drilling and completion capital budget of $675 million to $700 million reflects an impact of approximately 5% from service cost inflation. This inflation includes the net benefit of expected sand savings from our regional sand mine.” – Paul Rady, President & CEO, Antero Resources
  • “On the cost side, structural operating efficiency gains in 2021 continue to drive our average cost per foot down by approximately 7% on average, year-over-year. In our 2022 budget, we expect modest cost inflation.” – Jack Stark, President, Continental Resources

Shifting Focus Towards Liquids

It is not newsworthy at this point to say energy prices bounced back over the course of 2021 as compared to the subdued levels seen over 2020. However, despite the significant increase in U.S. natural gas production (with no countering decrease in gas prices), several E&P management teams noted a shift back towards liquids in the latest earnings calls.

  • “While our 2022 lease operating cost per barrel-oil equivalent guidance is modestly above our 2021 level, this reflects our pivoting towards greater oil activity…” – John Hart, CFO, Continental Resources
  • “My comments today will focus on our current view of the liquids markets, more important than ever given we are fully unhedged on all oil and NGL production as of the start of 2022. The past few months, we have seen crude prices reaching their highest levels since 2014, with Brent and WTI touching these 7-year highs supported by global supply concerns and geopolitical tensions across several key regions. At the same time, demand has surprised to the upside and market demand forecasts have been revised upward, primarily due to the more muted impact of Omicron on global consumption compared to previous COVID variants. NGL prices have also benefited in the current bullish price environment.” – David Cannelongo, Vice President – Liquids Marketing & Transportation, Antero Resources

Policy Headwinds

In our Energy Valuation Insights coverage of Appalachia, we noted a strongly worded letter sent from Massachusetts Senator Elizabeth Warren to natural gas E&P operators for the purpose of “turning up the heat on big energy companies who are gaming the system by raising natural gas prices for consumers to boost profits and line the pockets of executives and investors.”  Controversy regarding the perception, whether real or imagined, that the U.S. E&P industry holds enough power to materially or unilaterally guide global energy prices is nothing new. However, several comments made in the Q4 earnings calls suggested a deeper underlying sentiment from E&P management teams that certain industry headwinds are the direct result of certain national policies.

  • “We are proud to play our role in supporting U.S. energy security, which protects the U.S. consumer and serves as a powerful tool of foreign policy providing options for both the U.S. and our allies. We must take on the dual challenge of meeting the world’s growing energy needs while also prioritizing all elements of our ESG performance, including efforts to address climate change. This is not an either/or proposition and failure on either front is not acceptable. However, our approach must be pragmatic and grounded in the free market, innovation and an ‘all of the above energy’ approach. We are unfortunately experiencing firsthand the impacts of misguided energy policy and the dramatic role it can play on energy affordability as well as geopolitical stability.” – Lee Tillman, President & CEO, Marathon Oil
  • “I may add one other thing that I know you would have seen some of the comments from the Federal Reserve, if I can, this morning about, ‘Do you want to go and target industries?’ [We note that the referenced comments from the Fed could not be readily verified], and so I think that’s why you’re seeing us and probably the industry at large being very focused on getting that net debt down, because there is potentially a targeting of this industry to not be friendly toward lending money term.” – Bill Berry, CEO, Continental Resources
  • “What you’ve got right now, not just within Appalachia, but nationally, is a policy that is designed basically to not have a natural sort of [pipeline] investment occur to match something like the supply of natural gas to the demand centers. I don’t know if, at last, we’re starting to see some problems manifest with respect to that type of policy.” – Nick Deluliis, CEO, CNX Resources

Mercer Capital has its finger on the pulse of the E&P operator space. As the Oil & 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.