As discussed in our recent blog post regarding tempered mineral and royalty valuations despite recent oil price gains, sentiment towards the oil & gas sector turned bullish as the fourth quarter progressed, with WTI crude spot prices surpassing $40/barrel and – more importantly – generally staying the course on an upward trajectory to close out the year. Over the fourth quarter, WTI spot prices rose 21% from $40.05/barrel at the close of September 30 to $48.35/barrel at December 31. Similarly, Brent spot prices increased 27% from $40.30/barrel to $51.22/barrel over the fourth quarter.
One key factor supporting this price appreciation was OPEC’s decision to not flood the global market with crude oil. The election in November concluded with the election of Biden to the White House, a Democratic majority in the House, and uncertainty in the Senate as Georgia would have runoff elections in early January with its two seats – both held by Republican candidates – challenged by Democratic candidates.
Despite little indication as to what, precisely, the legislative branch would look like following the Georgia Senate runoff elections, the national election results up to that point made it clear that the oil & gas industry would most likely face headwinds from Washington D.C. with respect to industry operations. Energy prices, however, did not seem to reflect a change in course either way. In this post, we capture the key takeaways from fourth quarter 2020 earnings calls from E&P operators.
Heightened Caution Regarding Price Volatility
Throughout the earnings calls, the absence of COVID-19 as a factor of uncertainty was particularly striking. The majority of references to the pandemic were in passing, usually to provide context of the operational status in the fourth quarter 2020 relative to the same period in the prior year. Only one company executive, Harold Hamm of Continental, directly cited the role of public optimism regarding vaccinations as a driving factor behind the recent rebalancing of global crude oil inventories.
It appears as though the impact of the COVID pandemic on energy demand is no longer considered as much of a wildcard in E&P operators’ forecasts as it was earlier in the year.
While the pandemic is no longer a surprise, with operators fairly optimistic about short-term (1 to 3 years) projections, there is still the poignant memory of crude oil futures prices dipping into negative territory nearly a year ago. Yes, it has almost been a year already. The memory is indeed still very fresh, and operators are looking to protect themselves accordingly, whether via hedging or with greater conservatism regarding return of capital to shareholders by way of dividends.
“Our hedge book really helps on just the comfort and confidence and what these cash flows look like for the next several years with approximately 90% [of volumes hedged] in 2021. We already have a material position in 2022. And then if you look at 2023 and 2024, it’s getting close to almost being 50% hedged…” – Don Rush, CFO, CNX Resources Corp.
“Historically, [Occidental Petroleum has not] regularly engaged in hedging, preferring to realize the prices over the cycle, that delivers the most buyer shareholders. But we did…take on an oil hedge in 2020 that had a collar in 2020, but then it also had a call provision in 2021.” –Rob Peterson, CFO, Occidental Petroleum Corp.
“[We are] sticking with our priorities of managing capital expenditures supportive [of a] flatter production profile, then combined with protective hedges allows for maximum free cash flow generation, strong liquidity and debt reduction in long-term price recovery…” – Roger Jenkins, CEO, Murphy Oil Corp.
“Our primary focus will be debt pay down, but we are also focused on the eventual reinstating of our dividend… At this time, we would like to build more protection against price volatility by paying down debt, but our management and the board are aligned in wanting to see the return of a sustainable and growing dividend sometime in the near future.” – John Hart, CFO, Continental Resources, Inc.
Positive Free Cash Flow
Despite the price volatility leading up to the fourth quarter, many operators either posted annual free cash flows well in advance of projections, or at least finished 2020 on a positive note.
“2020 marked the most successful year we’ve seen as an E&P and, frankly, as a public company going back to the late 1990s, as measured by free cash flow…Our original guidance for 2020 free cash flow is around $135 million, compared to over the $356 million that we actually posted.” – Nick Deluliis, President & CEO, CNX Resources Corp.
“Our fifth consecutive year of free cash flow, we said, we’d generate $200 million. We generated nearly 40% more, $275 million.” – William Berry, CEO, Continental Resources, Inc.
“Even as activity levels increased in the fourth quarter and we returned to paying deferred dividends and cash, we still generated approximately $800 million of free cash flow…” –Rob Peterson, CFO, Occidental Petroleum Corp.
“Free cash flow during the quarter was $155 million.” – Glen Warren, Jr., Antero Resources Corp.
Compared to our review of themes in the third quarter E&P earnings calls, the fourth quarter earnings calls had a bit more discussion concerning ESG initiatives, including plans of action beyond “we expect to publish our ESG plan soon.”
“Our enhanced oil recovery projects [have] turned into an ability for us to create a new business that not only will add additional value for our shareholders over time but reduces emissions in the world. We’ll be the leaders in helping to test direct air capture technology, put it in place, make it operational and commercial, and that will provide an opportunity for others to expand it in the world.” – Vicki Hollub, President & CEO, Occidental Petroleum Corp.
“From a big picture perspective, if you look at sustainability and ESG…we translate what that means into really three crucial legs. One, you got to be transparent… Two, tangible, okay, these things, these targets, these metrics need to be measured. They need to be tangible. Like what did we actually deliver on? And then the third piece of this is actions, right. I think it’s pretty simple across those three, but despite all the talk and the volume of stuff that’s being bantered about across those metrics, I think those three things are lacking quite a bit. We want to be in the camp of, ‘Hey, here’s what we’re going to do, transparently. Here’s what we’re going to measure and accomplish tangibly. And then here’s what our actions were that were consistent with those two things.’” – Nick Deluliis, President & CEO, CNX Resources Corp.
“Our operations team continues work on minimizing our environmental impact such as building a new produced water handling system, as well as utilizing bi-fuel hydraulic frac spreads on all well completions in Canada, which results in considerable CO2 emissions reductions. While smaller changes individually, they add up to a larger impact over time.” – Roger Jenkins, CEO, Murphy Oil Corp.
On the Horizon
Throughout 2020, the oil and gas sector was rife with uncertainty regarding the COVID pandemic and its short- and long-term impacts on the energy markets. From some perspectives, there were 47 E&P operator bankruptcy filings in 2020. The worst year in the past 5 years in terms of the number of E&P operator bankruptcy filings was 2016, with 70 filings. However, some E&P operators proved that operational and capital discipline could still result in free cash flow sufficient to reduce debt and return capital to shareholders.
Despite the upward trend in crude oil and natural gas strip prices in the fourth quarter and generally favorable sentiment that the trend would likely continue into and through 2021, there was very little commentary on expectations of increasing rig activity.
Perhaps more surprisingly, and with the exception of Murphy Oil’s earnings call, there was also not much discussion regarding the Biden-Harris administration and its actions and intentions, which generally provide for stronger headwinds coming from Washington D.C. than what the industry has been used to over the prior four years.
We expect a clearer picture of E&P operators’ perspectives regarding future changes in the “boots on the ground” and regulatory environment in our next review of first-quarter 2021 earnings call themes.
For more information or to discuss a valuation or transaction issues in confidence, please contact us.